March 26, 2020
The Fed’s various liquidity facilities have eased some market stress, evidenced by the contraction in High Yield credit spreads. Monday was the widest at ~861bps and they’ve since narrowed to 590bps. As discussed last week, the narrowing of HY credit spreads would be the likely trigger for a bounce in equities that we estimated to account for 10-25% upside. The past three days resulted in a ~17.5 SPX bounce, which happens to be right in the middle of our range and into technical resistance. We expect further narrowing as timing/pricing mismatches settle over the course of weeks. But spreads will stay wider than usual (were 300bps coming into this event) until oil prices rise and US containment restrictions ease.
Skepticism around the sustainability of the bounce rightly comes into view, which could soon lead to a retest of Monday’s low. As noted yesterday, these retests typically result in a slightly lower low, which feels extremely uncomfortable because the retest could, quite possibly fail. In the very short-term, we consider the quarter-end rebalancing tailwind as legitimate reason to expect some added equity support. Again, adding to equities prior to a peak in US infection rates, requires an ability to withstand further possible drawdowns over the next 2-3 months. But also expect markets to be about ~2 weeks ahead of the data.