Low credit spreads and surges in “extreme greed” often reflect a fervor which disregards proper risk assessment.
After four months of rapid growth, the S&P 500 is sitting comfortably near its all-time high.
CNN’s Greed and Fear Index, a widely cited barometer of market sentiment, currently stands at 78 out of 100, in the territory of “extreme greed.”
Credit spreads: on par with months leading up to the 2007 recession
Credit spreads confirm this assumption. The chart below shows the difference between the yield on corporate bonds (higher credit risk) and the yield on Treasury bonds (lower credit risk).
Right now, credit spreads are extremely low. This means investors see very little risk in buying bonds with higher credit risk.
Apart from 2021, when the Fed’s QE programs were crushing risk premiums, the last time we saw credit spreads this low was March of 2007 – months before the onset of the Global Financial Crisis.
Prudence demands a contrarian stance
It is an odd fact that markets tend to suffer sharp reversals at the extremes. When market indicators look too good to be true (full employment, falling inflation, skyrocketing stock markets, low credit spreads), perhaps prudence demands a contrarian stance rather than blind adherence to the crowd.
The greatest opportunities arise when markets reach irrational extremes of exuberance or panic.
