Credit Markets Are Finally on the Same Scary Page as Stocks

Credit markets have mostly shown resilience in the past year as stocks were buffeted by everything from the trade war to oil shocks. With the coronavirus, it finally looks like there’s a threat that registers with both asset classes.

As the illness and its potential economic toll spread outside China, credit investors are on the verge of following their equity peers and giving up 2020 gains. Risk premiums on U.S. junk bonds have spiked to their highest since October, mirroring the sell-off in the stocks where companies with the weakest balance sheets have been hit the hardest.

In a sign of the increasingly gloomy outlook, investors are also rushing to short a benchmark exchange-traded fund that tracks corporate bonds at a faster pace than they are for the equity equivalent. The biggest junk-bond ETF saw a record $1.57 billion flee in the latest session.

While the credit moves are a long way from a broad capitulation, they’re a worrying sign. The debt market remained reasonably calm through bouts of turmoil last year, underscoring investor confidence in the business cycle in the face of various macro threats. Now even primary corporate bond sales are grinding to a halt.

Credit investors shrugged off everything from global trade tensions and geopolitical turmoil in Iran to Europe’s ongoing malaise and Brexit as short-term issues which could be fixed by central bank stimulus if needed, reckons Suki Mann, founder of Creditmarketdaily.com. The virus may be different, he wrote in a note to clients this week.

“The longer-term ramifications are there for all to see,” Mann said. “The corporate sector’s earnings/revenue chill could prove longer lasting. In credit, corporate fundamentals will come under pressure, especially if the COVID19-related slowdown” runs into the second-half of the year, he wrote. “There’s a high probability that this might be the case.”

The end of the risk rally in credit can be seen in the fact that 2020 returns have almost evaporated in the Bloomberg Barclays global high-yield bond index, now the worst-performing of 20 major gauges. The MSCI All-Country World Index of stocks erased its gains for the year on Monday.

Meanwhile, bearish bets this month on the iShares iBoxx Investment-Grade Corporate Bond ETF are near the most elevated in eight months. Since mid-January they have risen significantly faster than those on stock peer SPDR S&P 500 ETF Trust.

Both asset classes were riding high in recent weeks, with the global equity gauge at a record and U.S. corporate bond spreads at unprecedented lows. The extreme pricing made them vulnerable as investors, businesses and officials got more gloomy over the outlook for the virus.

“The environment for credit is going to get a little bit harder than it’s been,” Peter Tchir, head of macro strategy at Academy Securities said in an interview with Bloomberg TV Tuesday. “Downgrades are a concern. Once I start seeing rating agencies move, it tells me they want to be ahead of what they might perceive as a recession.”

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