Market Extremes: Are We Headed For Another 2008 Crisis?

MARKET EXTREMES: ARE WE HEADING FOR ANOTHER 2008 CRISIS?

A recurrent theme of our posts is the great value we set in paying attention to extremes of behaviour in markets, for they often offer clues to upcoming trend changes.

The accompanying chart illustrates a market extreme that was last seen just prior to the 2008 Financial Crisis. The interest rate spread between high-yield (aka junk) bonds and their high-quality counterparts has narrowed to the lowest level since 2007!

The extreme investor bullishness that this reflects is worthy of note because extremes of sentiment have historically proven to be a reliable contra-indicator for both credit and stock markets.

The bullish sentiment is being largely driven by the narrative embraced by consensus opinion that the Federal Reserve will continue to aggressively cut interest rates over the next 12 months and that a recession will be avoided. We find the two notions to be paradoxical. Investors can have one, but not the other.

Investor consensus opinion, and markets, are vulnerable to disappointment on rates. If a recession can indeed be avoided, the implied economic strength will put upward pressure on inflation which will limit the Fed’s ability to lower rates. As well, the appearance of significant import tariffs as pledged by the incoming Trump administration will put significant upward pressure on inflation, perhaps eventually requiring the raising of interest rates to avoid a repeat of a 1970s-style stagflationary economic environment.

The extreme contraction in high-yield spreads reflects complacency on the part of investors and adds to an already concerning list of potential economic and geopolitical catalysts for market volatility in the months and years ahead.

The market volatility that we believe will come to define the 2020s will pose risks and be emotionally jarring but will also offer significant opportunities for prepared investors across markets and asset classes.

As always, we’ll be sharing our analysis of unfolding events and investing activities each month in the Global Investment letter. If you found this post insightful, imagine the value you’ll get out of the full letter. Subscribe now to our free weekly investment comment (exclusive to those who signup) and gain access to free sample issues of the Global Investment Letter.

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