This ‘green light’ for stock-market investors is coming from the bond market


The bond market is expressing confidence in company cash flows, flashing a sign of support for the stock market’s rally, according to DataTrek Research. 

“U.S. corporate bond spreads continue to tighten and are now essentially the same as 2017–2019,” said Nicholas Colas, co-founder of DataTrek Research, in a note emailed Monday. “That is a green light for further stock market gains.”

Declining corporate bond spreads over comparable Treaurys signal rising confidence in future cash flows and earnings, said Colas. Both investment-grade and high-yield bonds have broadly seen their spreads tighten over the past few weeks to average levels seen in 2017–2019, when conditions in the economy were generally good, his note shows. 

Investment-grade spreads averaged 1.19 percentage points over Treasurys over that stretch, while junk bonds averaged 3.82 percentage points, according to Colas’s research. 

“This was a period of generally good economic conditions and just one hiccup in capital markets, namely when the Fed briefly overreached on rate policy in late 2018,” he said.

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This year, investment-grade bond spreads have recently declined to around 1.22 percentage points and those for high-yield debt have narrowed to 3.78%, the DataTrek note said. 

“Corporate bond markets continue to mirror equity market confidence” in stable and strengthening company cash flows, Colas said. “This is not only supporting the ongoing rally in large caps, but also helping small caps outperform in July.”

The Russell 2000 index RUT, +1.09%, which tracks small-cap stocks in the U.S., has climbed 4.9% so far this month, exceeding the S&P 500’s 3% gains over the same period, according to FactSet data. The Russell 2000 has been trailing the S&P 500 in 2023, though, with 12.5% gains so far this year.

Earlier this month, Bespoke Investment Group also pointed to high-yield bonds as the latest indicator confirming the equity market’s rally. The S&P 500, a gauge of U.S. large-cap stocks, has jumped 19.3% this year through Friday.

Citigroup analysts said in a research note on Friday that they raised their 2023 target for the S&P 500 by 600 points to 4,600, while revising up their mid-2024 target to 5,000, from 4,400.  

The popular stock-market index SPX, +0.15% closed Friday at 4,582.23.

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