Corporate defaults continue to surge in 2009 despite signs of “green shoots” all about us. We’ve spoken previously of the correlation between corporate defaults and stock market bottoms. S&P is out with a new research report saying corporate defaults will reach 14.3% in 2010 and could move as high as 19% if the economy remains weak.
“Relevant credit metrics in the U.S. show continued deterioration of credit quality and restricted lending conditions, contrasted with the first signs of life among new issuance. The preliminary estimate for the U.S. 12-month-trailing speculative-grade default rate in April is 7% (subject to revision), up from the 5.4% in March and much higher than the 1.72% reported in April 2008.”
Corporate defaults have a very high correlation with the stock market for natural reasons – obviously, the potential of increased defaults and bankruptcies is reason to sell stocks. If we are currently half way through S&P’s total estimate of defaults (which are expected to peak in 2010) is it realistic to assume that the stock market has already bottomed? I am doubtful. As you can see in the chart above the corporate default rate has had a very high correlation with market bottoms. Defaults topped in near unison with the market bottom in both the ’91 and ’01 recession. What about the Great Depression – the last large credit crisis in the U.S.? The results are much the same. The corporate default rate topped in near unison with the stock market:
So, has the stock market bottomed? Not if the corporate default rate has anything to say about it. In fact, we might not even be close if S&P’s “pessimistic” scenario pans out…
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Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.