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Recession Watch

CAMS Weekly View from the Corner - Week ending 3/15/24


March 18, 2024


When a topic pertaining to the outlook of recession is opened it invites a massive discussion as there are seemingly endless tools to dial up in order to see what the economic tea leaves are suggesting.

 

For our part today we will stay quite specific with one of our favorite approaches toward viewing what the downstream economic backdrop may look like.  Importantly, like all tools there is no end all be all metric that offers one hundred percent downstream accuracy but some are better than others.

 

The bond market, always a contender for the smartest market, is a good place to focus. 

 

There is an adage that offers when you are playing for mere basis points you need to have your broad analytical skills together so hence entrenched bond market participants are nobody’s fool.  They are smart and the collective messaging left in the wake of their trading is important and offers useful information.

 

There have been those over the previous couple of years (with a building momentum in recent months it seems) who have offered the economic backdrop is doomed and hence will be rolling over into an abyss “any month now” if we are digesting their views correctly. 

 

The offered abyss via X messenger often rivals the Great Depression era.  This may hold true – we are open minded to nearly any downstream outcome.

 

We have learned the essentialness of an open mind via observation and the long historical study of the travails of human history.  Undergo that pursuit long enough and it will blow your mind wide open to X outcomes.

 

At the same time, and this is a biggie, it is amazing how the general storyline of human history has many times looked its darkest - with a seemingly overwhelming certainty of X outcome - only to continue on or to turn in a unexpected positive direction. Importantly, the opposite holds true as well.

 

The bottom line of either sides of the ledger – have an open mind to all possibilities and do your best to quantify near-term/downstream risks.

 

We use the bond market as just one tool - an important tool - to do just that. 

 

Corporate Bond Market

 

The bond market is a very broad market with many entities issuing bonds that are then traded among bond market participants.  Corporate bonds are a large segment of the bond market but even within this segment there are differences.  One such difference is the general credit quality of the issuers. 

 

We have some general types such as High Grade corporate as well as High Yield corporate. 

 

High Grade corporate bonds are of higher credit quality issuers while High Yield corporate bonds are often referenced in slang as, “junk bonds,” reflecting the lower credit quality of their issuers.

 

These are two broad categories that we will focus on to keep this edition out of the myriad of details within the bond market.

 

As an important backdrop, keep in mind that market participants price assets today according to what they believe the general landscape will look like downstream.  Bond market participants do this as an obsession. 

 

Again, when you are playing for basis points you better have your act together and getting the downstream view as correct as possible is a huge part of that act.

 

If these participants collectively conclude economic recession is presenting itself, “any month now,” they will begin to sell bonds of the issuers that are most economically vulnerable.  The High Yield (junk) bond issuers fall under this umbrella as prime candidates. 

 

Enter the Tool

 

If bond participants fear recession they begin to sell High Yield (junk) bonds in earnest which puts downside pressure on their prices.  When compared to their selling of High Grade bonds, junk bonds go down in price far more than their High Grade counterparts.  Makes sense right? 

 

The riskier assets will be sold first and more rapidly than the less risky assets if a recession is determined to be heading our way.

 

Below we place these two categories together via a relationship chart and let them offer their message.

Above is a near 20 year chart in order to offer some historical perspective.  This is corporate High Yield (junk) bonds to corporate High Grade bonds placed together.  This means as the line moves downward High Yield bonds are significantly underperforming High Grade bonds. 

 

Our red down arrows highlights notable instances of this over the previous couple of decades.  Two stand-out timeframes were the 2008/09 Great Recession and the Covid Recession.  High Yield bonds were crushed relative to High Grade bonds with hard south red down arrows.

 

Our blue arrow highlights the outperformance of High Yield corporate bonds compared to that of High Grade corporate bonds in recent time.  Importantly, this includes up to current day.

 

Our blue arrow offers bond market participants are not seeing a recession downstream.  High Yield bonds are handily outperforming on a trend basis.  As always, this is subject to change which is why we keep an eye on all these types of tools in order to decipher whether messages are changing. 

 

Rest assured, using history as our guide, this will change given enough time.  Today though, the trend message is clear in favor of High Yield bonds.

 

Corroboration

 

With the above relationship chart in mind we can take the same approach for various areas of the bond market to see if the overall message is corroborated.  Current day, the message is consistent which is to say bond market participants are not messaging an imminent concern for recession.

 

Collective bond market participant messaging gives us their forward view - not with a simply offered opinion based on X theory or measure but rather with capital placed down (or taken away) from the various segments of the broad bond market.

 

As we offered in a recent edition, this elicits the old phrase, “Money talks, BS walks” offering it is easy to talk right but if that talk is backed up by capital then that is a whole different level of conviction.  When conviction is backed up by capital it usually offers an entirely different level of due diligence which further enhances the messaging of collective market participants.

 

For now - no recession – is the message via collective bond market participants.

 

I wish you well…


Ken Reinhart


Director, Market Research & Portfolio Analysis

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