Great thoughts here from David Rosenberg:
Chart 2 is a bar chart of Baa corporate spreads comparing where we are (374bps) to where we were (611bps at the end of last year) as well as to other periods of intense economic, financial and geopolitical strains. To be sure, corporate spreads have come in a long way from their nearby crisis highs but looking at prior peaks around major events and economic downturns, it does appear as though there is still a lot of very bad news priced into the sector.
As an example, spreads are still quite a bit above those huge levels from 2001-02 when we faced the triple whammy from the tech wreck, to 9/11, to the Enron/WorldCom crisis. At 374bps, spreads are now in line with levels we saw around the 1982 Penn Square failure and the 1937-38 relapse in the economy and stock market as well as being 100bps above the Crash of ’87 levels.
There is little doubt that we are never going back to the tight 150bps spread levels during the credit boom and the long-run average of around 200bps given the lingering sizeable amount of economic, financial and balance sheet uncertainty. But I would think that Baa spreads can pretty easily get into a 250bps to 300bps zone for a sustained period of time before we (hopefully) stabilize.
From some back-of-the-envelope calculations I did, the corporate bond market may have priced out the Armageddon scenario in the past six months, but there is still plenty of “recession protection” embedded in the current level of spreads — still discounting around -2.0% U.S. real GDP growth for the coming year (I give that less than 1-in-5 odds) and an 11.5% unemployment rate (I give that 1-in-3 odds).