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Goldman Warns IG Credit Collapse Signals S&P 500 Notably Overvalued

Tyler Durden's picture




 

The sell-off in credit over the past week has led many investors to ask what it means for equities. Credit spread widening usually has negative implications for equity but as Goldman notes,  it is critical to estimate the degree to which the equity market has already priced the weakness to determine the potential risks to equity going forward. Interestingly, Goldman finds the weakness in high yield credit was foreshadowed by weakness in the equities of high yield companies (like for like), but the weakness in Investment Grade credit spreads relative to their corresponding equities represents a new divergence suggesting meaningful downside for S&P 500 investors.

HY credit weakness has caught up with HY equity weakness
Goldman's analysis shows that the weakness in high yield credit was foreshadowed by weakness in the equities of high yield companies. This month’s 80bp widening in the CDX HY 5Y to 514bps was extreme relative to history; however, Exhibit 1 shows this move can be more than explained by the 25% decline in their corresponding equities (GSCBHY25) since April 1 and the large dislocation that had developed.

But.. There is reason for concern: A new dislocation in IG credit/equity
The weakness in Investment Grade credit spreads relative to their corresponding equities (GSCBIG25) represents a new divergence we are monitoring closely. In Exhibit 3, we show that after trading in line with each other for months, IG equities have outperformed IG credit by 4% over the past two weeks. This represents a 1.3 standard deviation divergence relative to the past five years. Due to the substantial overlap between names in the IG index and the S&P 500, we see this overvaluation in IG equity vs credit as meaningful for S&P 500 equity investors.

 

Finally, Goldman note that the cost of protection (on an apples to apples basis) is modestly higher in equity than it is in credit markets out to around 5 years...

 

Though as practitioners, we note 1) the 55% OTM is not entirely fungible with CDS payoffs, and 2) there is an exogenous desire for systemic risk reduction in S&P 500 puts (as we detailed here)...

New research suggests the divergence is a consequence of financial institutions hoarding insurance against declines in stocks.

Source: Goldman Sachs

 

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Tue, 12/15/2015 - 15:44 | 6927039 THE COIN
THE COIN's picture

Festivus is here.

Tue, 12/15/2015 - 16:03 | 6927107 El Oregonian
El Oregonian's picture

*Critical Mass!*

"I'm giv'in all she's got cap'pin. She can't take much more! She's ready to blow!" - Scotty

Tue, 12/15/2015 - 15:45 | 6927041 arbwhore
arbwhore's picture

"Goldman warns" ... so... bullish then....

Tue, 12/15/2015 - 15:46 | 6927045 Dr. Engali
Dr. Engali's picture

Soooo...., BTFD hand over fist then.

Tue, 12/15/2015 - 15:46 | 6927047 LawsofPhysics
LawsofPhysics's picture

something everyone around here has been acutely aware of....

mind the rug...

Tue, 12/15/2015 - 15:53 | 6927064 prefan4200
prefan4200's picture

That rug really tied the room together, man.

Tue, 12/15/2015 - 16:00 | 6927102 GartmansTaint
GartmansTaint's picture

Until Woo peed on it...

Tue, 12/15/2015 - 16:07 | 6927131 LawsofPhysics
LawsofPhysics's picture

...or it gets yanked out from underneath you.

Tue, 12/15/2015 - 18:42 | 6927834 tarabel
tarabel's picture

 

 

He tore our carpet.

Tue, 12/15/2015 - 15:50 | 6927062 buzzsaw99
buzzsaw99's picture

that means sell your ig to the squid

Tue, 12/15/2015 - 16:09 | 6927143 WTFRLY
WTFRLY's picture

Are joo surprised by this?

Tue, 12/15/2015 - 15:53 | 6927069 adr
adr's picture

Stocks are more overvalued than the cubic zirconia on Lloyd Blankfein's twelfth fake breasted whore.

Tue, 12/15/2015 - 15:58 | 6927093 madcows
madcows's picture

so who can distiguish between Investment Grade and Junk?

I see no difference myself.  It's all a big f'n high risk market, and the yields ain't worth it.  f'em all.

Tue, 12/15/2015 - 16:05 | 6927122 BSHJ
BSHJ's picture

Was the SnP 'Notably Overvalued' before or after the UP moves today?

Tue, 12/15/2015 - 16:26 | 6927207 The worst trader
The worst trader's picture

Not a chance! way more freee money to come.Obummer is not done fucking the sheeple.

Tue, 12/15/2015 - 17:17 | 6927432 Glass Seagull
Glass Seagull's picture

 

 

Selling of these overvalued puts is going to make the market fly.

Tue, 12/15/2015 - 17:26 | 6927479 tarabel
tarabel's picture

 

 

Companies have been using free borrowed money for stock buybacks that support their equity price.

Take away the free credit and you take away future stock buyback orgies.

One more step on the long road back to financial reality.

Tue, 12/15/2015 - 17:30 | 6927498 LawsofPhysics
LawsofPhysics's picture

Maybe.   Where is the point at which the stock buyback becomes "too expensive"? 

even a 0.25%, a company could buy fucking treasuries and still be fucking "profittable."

that is the question, I plenty of room for business as usual when you are already sitting on fucking zero.

Tue, 12/15/2015 - 19:10 | 6927958 tarabel
tarabel's picture

 

 

I think the point at which financed stock buybacks become too expensive is when a continuation of rates can no longer be counted upon. 

The primary reason for such activities is to mask the hidden (to the public) real condition of business. Yet conditions are in fact steadily deteriorating, which shrinks the true revenue available for debt servicing even the existing pile of bonds.

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