With large-cap or mega-cap technology earnings pretty much over with this week, (Nvidia (NASDAQ:NVDA) reports late August ’24, and then Oracle (NYSE:ORCL) in September ’24), earnings season unofficially ends August 15 ’24, with Walmart Inc's (NYSE:WMT) 2nd quarter report.
The weakening economic data has led to speculation about a hard landing or more-importantly recession risk ahead, which could very well happen, but high-yield credit spreads have yet to widen meaningfully, and that’s usually a good indicator of how bad a recession might be looming.
Bespoke publishes a credit spread indicator for both the high-yield credit market (below BBB-/Baa3 rated corporate bonds) and the high-grade or investment-grade credit market (BBB-/Baa3 and higher) which gives Bespoke readers a good read on the market without a high level of detail.
Late in ’23, when investors saw that spate of weaker economic data and the 10-year Treasury yield traded down to 3.785%, the Bespoke high-yield spread average traded above 400 (+415 in early November ’23) but has since dropped down to the low 300’s in July ’24, May ’24 and then again in early April ’24.
Spread widening can occur with worries about credit deterioration for sure as a slower economy means lower growth or slower growth in corporate cash-flow, and debt service coverage metrics begin deteriorate, but the spread widening can also occur with heavy issuance, which means greater issuance of higher-yielding, below-investment-grade credits is going to widen spreads to accommodate that supply.
If you, as an investor, are worried about deteriorating credit profiles, stay with investment-grade bonds and bond-funds, and ETF’s or even the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSE:LQD).
Higher-credit-quality corporate bond ETF’s will have a higher duration than the high-yield ETF’s and lower credit risk. High-yield ETF’s like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSE:HYG) and iShares 0-5 Year High Yield Corporate Bond ETF (NYSE:SHYG), will have higher yields and coupons, and lower-credit rated bonds, with a lower duration.
From back during covid in 2020, there should be a large “maturity wall” for high-yield corporate bonds (and muni’s) in 2025, so keep that in mind as we get closer to the 5-year anniversary of Covid, i.e. March, 2025. It shouldn’t take much in fed funds rate reductions to see a lot of higher-yielding issuers take advantage of what will be higher refinancing yields, but lower than what they are looking at today.
S&P 500 data:
- The forward 4-quarter estimate fell this week to $259.51 from last week’s $259.84 and resumed a more normal pattern than what we saw in the calendar 2nd quarter, when there were continuous sequential positive revisions;
- The PE on the forward estimate (assuming a 5,328 close which is where the S&P 500 is trading with 90 minutes left in the trading day), is 20.5x versus last week’s 21x;
- The S&P 500 started ’24 with a 19.25x PE in early January ’24;
- The S&P 500 earnings yield will end this week 4.87%, the highest since mid-April’s 5%. (I forgot about that April ’24 correction – the S&P 500 fell 4% for the month of April ’24 and the S&P 500 earnings yield tipped the 5% mark.)
- The full-year ’24 and ’25 “expected” EPS growth for the S&P 500 is 10% this year and ‘15% in ’25. That hasn’t changed much, but let’s watch the weekly data and see what transpires;
- The S&P 500’s “upside surprise” is just 3.6% for Q2 ’24 and after tech has reported, that’s well below the first half of ’24’s pace;
Summary:
Obviously, the big news this week is the rally in Treasuries and the drop in the 10-year Treasury yield to 3.785%, which was exactly the low yield in late December ’23.
Readers should remember that every time the mainstream media and the Wall Street prognosticators thought the US was headed into a recession, (2022, March of ’23 with Silicon Valley Bank blowing up, late ’23 with the temporary slowing in economic data), the US economy reaccelerated from those points and left everyone holding their higher-duration bonds.
Housing and autos are the two “consumer discretionary” groups that have typically led the US into and out of recession, while housing unit sales have slowed, prices seem to have maintained their lofty pandemic peaks, but home sale activity is such a local market. Auto’s too have seemed to hold up. There is a credible contributor over on X (@GuyDealership) who tracks the auto business closely and in an email this week and he seemed to indicate that dealers were more bearish than bullish.
It’s clear some economic slowing is afoot, however, even if this is a recession we are looking at in early ’25, the probability this is ’08 like is less than 15% (in my opinion).
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Disclaimer: None of this is advice or a recommendation, but only an opinion. Past performance is no guarantee of future results. Investing can and does often involve the loss of principal, even for short periods of time. All S&P 500 EPS and revenue data is sourced from LSEG.com. None of the information herein may necessarily be updated and if so may not be done in a timely fashion.