U.S. High Yield Credit Spreads vs. S&P 500 VIX
Market pundits often report on the “VIX” or volatility index, but when markets are weaker, it seems to be discussed even more frequently. However, despite relatively strong markets over the past year, the VIX continues to be a popular talking point in the news, due to its recent historically low level. When the VIX is low, it implies that the expected volatility for that market is low. As a result, this suggests there is less expected dispersion of returns for a given market; therefore, it is expected to be less risky. This calm in the stock market and low VIX has coincided with returns for the S&P 500 Index of over 21% for 2017.
To look at the market implied expectations and risk from another perspective, an investor can follow U.S. High Yield (USHY) credit spreads. Note that credit spreads last year were relatively low, implying less default risk and a relatively benign environment for investing. USHY returned a solid 7.6% in 2017, also reflecting a relatively low-risk environment.
As seen in the chart of the week, both USHY credit spreads and the VIX for the S&P 500 Index have tracked one another pretty consistently historically. However, in early 2018 we saw a spike in the VIX while credit spreads remained low. That begs the question, which is the better gauge of risk sentiment for the markets for the coming year?
It appears that the most recent spike in the VIX for the S&P 500 Index may be more of an aberration caused by external variables such as the impact of levered ETFs and other noise in the VIX during February 2018. Credit spreads slightly corrected during the same time period, but not nearly to the same extent as the VIX. Subsequently, both have continued to move lower, implying less risk in the market and a relatively safe environment to invest for the future. Overall, I trust the move in the credit spreads to be a stronger indicator of the investing sentiment and continue to invest in the markets.
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High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
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