The Combined Credit Spread Model Falls to Unfavorable

Key points:

• Credit spreads serve as a "fear gauge" in the credit markets - narrow/falling spreads suggest calm, rising spreads suggest concerns
• Our Combined Credit Spreads Model recently fell into unfavorable status - suggesting limited upside and increased volatility for stocks while this status remains
• The Combined Credit Spreads Model is comprised of two credit spread-related indicators - ICE BofA US High Yield Option-Adjusted Spread and the CDX Index
• Part I reviews the indicators that comprise the Combined Credit Spreads Model

Indicator #1: ICE BofA US High Yield Index Option-Adjusted Spread

The ICE BofA US High Yield Index Option-Adjusted Spread (HYCS) measures the spread between the computed index of below-investment-grade bonds and the spot Treasury curve.  

We rate the spread as favorable when it is in a downtrend and unfavorable when it is in an uptrend. We designate its trend as follows:

A = HYCS weekly close

B = 13-week exponential average of A

C = 28-week exponential average of B

The chart below displays these variables.

From here, we take the difference between the two mov