Both the absolute levels and the implied volatility of credit markets are significantly divergent from the recovering exuberance in stocks. As we discussed here [7] and here [8], this cannot last. If you 'believe' that Bernanke was bluffing and the taper is off then credit is grossly cheaper than stocks; if not, equity shorts seem an appropriate position into Q3.
Easy Come, Easy Flow...
[9]
Which leaves equities 9-sigma rich to credit... (approximately 3x HYG to 1x SPY delta)
[10]
Of course, the fund flows are affecting credit (as we are constantly reminded on CNBC) and as we saw here, the selling pressure is dramatic; but - as we noted previously [11] -
there is no rotation that drives high-yield credit spreads wider without punishing equities. They are liabilities on the same capital structure and rise and fall in a highly correlated (well non-linear co-dependence) manner as the underlying business risk rises and falls. Do not, repeat do not, see high yield credit weakness as a sign of rotation to stocks - if the credit cycle has turned then stocks are set to fall. And bear in mind that while HY yields are at all-time lows, spreads are not and in fact being short stocks relative to credit makes more sense if you are you are a bear on the credit cycle here. The only problem being that the epic flows that sustained a credit market at non-economic levels for so long will exit in a hurry.
Charts: Bloomberg and Barclays