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Credit Markets Point To A Major Equity Correction

Credit is like a black box to most retail investors. It's a shame CNBC gives Rick Santelli only 10-15 minutes a day to report on this market. The Fed may set short term rates but the bond market sets everything else. From credit formation that fuels economic growth to interest rates that affect everyone's life the bond market is home to many smart investors and one market you do not want to ignore.

Credit markets have been efficient economic forecasters pricing in the past two recessions well before equities. Once again that little black box is speaking and once again equity investors think this time it's different. This time hedge funds and retail traders think they have outsmarted the bond market.

If asked the question what is fair value of the SPX if the economy weakens would you know? No one knows what "fair value" is yet everyday pundits try and tell us the answer. Credit markets have already priced in economic weakness and using history as a guide the charts below would put the SPX in the 700-800 level.

5-Year Interest rate Swap versus SPX

AAA Corporate Bond Yields versus SPX

Equities remind me of a famous Mark Twain quote.

"When I was a boy of fourteen, my father was so ignorant I could hardly stand to have the old man around. But when I got to be twenty-one, I was astonished at how much the old man had learned in seven years."

 

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