To say that 2016 has been a tough year so far for equities and equity investors would be the definition of an understatement.

However, equity investors will get no sympathy whatsoever from credit investors. As the following chart shows, while the performance of equities (e.g., the S&P 500 Index) has been bad of late, though punctuated by stronger episodes, credit has been underperforming consistently since the summer of 2014 (Exhibit 1).

In case you were wondering, the bottom for credit spreads coincided almost perfectly with the time the Federal Reserve (Fed) started talking about tightening policy. The credit metric here is the spread of the Barclays credit index, which unlike the high yield market is a very large, diversified, and robust index, versus Treasuries (Exhibit 1).

S&P 500 Index vs. The Barclays Aggregate Credit Index

Unfortunately, the performance of the credit markets continues to be poor. While equities have rallied some from the bottom, the recovery in credit really has been very fickle and modest at best.

For equity investors, the next question then is, while misery loves company and you are thrilled that you are not the only one having a tough go, why should you care?

To answer that question, look at the following chart, which shows a regression of the monthly percentage change in credit spreads versus the percentage change in the S&P since 1988 (Exhibit 2).

Return of the S&P 500 Index vs. The Change in Spread of the Barclays Aggregate Credit Index

The results show a statistically significant relationship between the monthly change in credit spreads and the monthly returns of the S&P 500 Index. Most of the observations are in the second and fourth quadrants and illustrate that equities rarely do well with spreads widening. Statistically speaking, it would be very difficult to imagine an environment where credit continues to do as poorly as it has been doing and equities rally in a big way.

From a macro standpoint, this makes perfect sense: Since the 2008 financial crisis, credit markets, far more than equities, have been driven more – and more contemporaneously – by Fed policy and risk-free rates because it is the same set of investors playing in both of those markets. Credit investors sensed the potential Fed move in 2014 and have been trying to adjust ever since. Equity investors, who have been far more bottom up, caught up to that change much later and are still adjusting.

The bottom line is that if equities are going to do well on a sustained basis, credit markets also have to do well. However, at the moment, there is not much to be hopeful about on that front based on credit analysis. I think that turnaround will come eventually, but we are not there yet.

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