Below are highlights from the NDW Morning Update Video for the morning of 10/22. Access the video on the NDW Morning Update Video page. 

• Equity indices edged higher over the yesterday, led by the Dow Jones Industrial Average (.DJIA), which gained 0.69%. The S&P 500 (SPX) advanced 0.58%, while the S&P 500 Equal Weight Index (SPXEWI) rose 0.34%.
• Meta Platforms Inc. (META) reported better-than-expected third-quarter revenue and issued stronger-than-expected fourth-quarter guidance. However, shares fell after investors focused on the company's rapidly rising AI-related spending commitments, including increased capital expenditure guidance and roughly $825 billion in future infrastructure obligations, which weighed on sentiment despite the earnings beat.
• The ten week for the S&P 500 (^TWSPX) has continued to tick higher and now maintains a chart level of above 50%, signaling a continual increase in near-term participation. The bullish percent for the S&P 500 (^BPSPX) also reversed back up over the past week, signaling an increase in intermediate-term participation.
• On the earnings front, a few major companies are expected to report earnings over the next week: Visa Inc. (V 5/5 TA Score on 10/27), Alphabet Inc. Class A (GOOGL 3/5 TA Score on 10/28), and Microsoft (MSFT 4/5 TA on 10/28).
• Yesterday’s research piece covered the improving relative strength in commodities, highlighting leadership from oil-related exposures such as DBO and showing how a relative-strength rotation strategy has historically outperformed a passive commodities allocation.

Recently, there have been signs that the appetite for credit risk is waning. Earlier this month the ICE BofA US High Yield Spread Index (HIGHYIELDSPREAD) reversed up into a column of Xs on its chart. Meanwhile, the other high yield spread index we track on the platform (CBUS10YRSPREAD) reversed up into Xs last month. Widening spreads have the same effect as rising interest rates—lower bond prices—and are therefore detrimental to bondholders.  High yield bonds have already weakened due to the widening spreads; in the Asset Class Group Scores, the average score for the high yield corporate group has fallen to 1.90 from 2.40 at the beginning of September.

While high yield spreads have a direct impact on bonds. They are also regarded as a bellwether for the economy (or economic sentiment) and equities. When investors are worried about the possibility of recession and by extension that borrowers (i.e., bond issuers) won’t be able to service their debt, they demand a higher return for the increase in risk and high yield spreads widen. Conversely, when the economy is perceived as being strong, investors are more willing to lend and high yield spreads contract. In an extreme example, high yield spreads widened by more than 700 bps in March of 2020 amid fears of an economic collapse at the outset of the COVID-19 pandemic. Last year, CBUS10YRSPREAD rose about 180 bps in March and April amid tariff worries.

While the economy and the stock market are not one in the same, there is a typically a strong relationship between the two and US equities have historically performed significantly better when high yield spreads are narrowing, indicating favorable economic conditions. The table below shows the quarterly performance of the S&P 500 when high yield spreads are narrowing versus when they are widening. It is also apparent that the magnitude of the change is also significant as the S&P has performed better during quarters when spreads narrowed significantly and worse when they widened by a large amount.

The risk-off move in credit has not been limited only to high yield bonds. The graph below shows the price history of a Markit credit default swap (CDS) index. It has risen significantly since the beginning of September and is now the levels it reached in March at the outset of the Iran conflict. The increase reflects greater demand for credit default swaps, suggesting that the market is more concerned about borrowers being able to service their debt obligations than it was a couple months ago. That concern has been cited as the reason that some AI-related companies, like CoreWeave (CRWV), have seen significant drawdowns recently. Ironically, worried investors may make it more difficult for these firms to service their debt as widening spreads drive up their borrowing costs. The upshot is that if we continue to see credit tighten it could be a headwind for firms borrowing to finance the AI buildout.

The practical implication of this relationship is that even investors without corporate debt exposure should an eye on credit spreads.  Widening high yield spreads are generally correlated with muted returns while narrowing spreads have historically been associated with a stronger equity market. Like widening spreads, rising CDS prices reflect a more risk-off posture in market and as CRWV has shown recently, that isn’t a concern only for debt holders.

We don’t want to overblow the significance of the reversals on the charts of HIGHYIELDSPREAD and CBUS10YRSPREAD as you can see there were other reversal in the last year that were ultimately short-lived. Like any other indicator, every chart reversal won’t end up being meaningful but movement in high yield spreads and other credit instruments can be a useful data point for diagnosing the state of the market.

The option suggestions featured here are pulled from the NDW Options Ideas tool. These are just a sample of the ideas that can be found there. The Options Idea tool contains numerous additional income and speculative plays. It also offers relative strength-based screens targeting the highest (and lowest) relative strength stocks and ETFs that have recently moved counter to their longer-term trend. To access or subscribe to the Options Ideas tool, click here.

Call

Amgen Inc. (AMGN) Jan 15 $440 Call

Put

CIENA Corporation (CIEN) Jan 15 $330 Put

Income

J.P. Morgan Chase & Co.(JPM) Dec 4 $320 Covered Call