Credit Conditions and Risk Taking

Jack Ablin

By Jack Ablin, CFA

Chief Investment Officer

The availability of credit, to borrow, spend or invest, is the lifeblood of the financial market.  That’s why credit conditions are a good indicator of risk appetite.  The easiest way to gauge real time credit conditions is by observing the yield differential between 10-year, BBB bonds and 10-year Treasury notes.  Since the bond market is roughly seven times the size of the stock market, the yield premium lenders require to extend credit to lower-quality borrowers is a useful barometer.

Rising credit spreads can also be early warning indicators of trouble.  Our credit spread model broke out in Q4/2007, four quarters – an entire year – before trouble swept through the broader markets.  While credit conditions are favorable today, spreads have widened in recent weeks and are currently situated just below their 200-day moving average.  Continued widening would be a risk-off signal.

Favorable credit conditions along with a favorable economic backdrop, reasonable equity market valuations and positive momentum are keeping us engaged in equity risk-taking.  That could change should credit conditions deteriorate.

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