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By Steve Goldstein

It can get messy on Wall Street when corporate bond yields climb.

The corporate bond market has been flashing a signal that historically precedes bad news for the stock market.

It's the gap between the yield on Triple-C and Single-B rated debt. Both are known as junk bonds, but the single-B means a company is vulnerable while Triple-C means it's at substantial risk of default.

Bobby Molavi, head of European execution services at Goldman Sachs, flagged in a note to clients the disappointing stock-market results that have ensued when the difference in yield between the two classes of corporate debt reaches 8%. That gap first reached 8% on Sept. 24 and now stands at over 9%.

The gap between the yields on CCC and B corporate debt

MarketWatch, using FactSet data, found at least five previous times that the gap reached 8% - in 1999, 2000, 2008, 2015 and 2020.

In 2008, the S&P 500 had already tumbled by 43%, during the global financial crisis. It ended up in a drawdown of 53%, so the declines after the yield gap between those two grades of junk bonds reached 8% were not that much worse. The 2020 episode, similarly a few weeks after COVID-19 was discovered in the West, had already resulted in a 24% drawdown for the S&P 500, that at its worst was a 27% drawdown.

The 1999 episode seemed to hit with a lag. On March 31, 1999, the S&P 500 had already fallen 2% from its peak. It then climbed for three months before falling 12% by mid-October.

The 2000 and 2015 episodes may be more illustrative.

On Jan. 3, 2000, the S&P 500 was down just 1% from its highs, and it ended up sliding 17%. On Nov. 30, 2015, the S&P 500 was a little over 2% away from its high, and it fell as much as 14%.

Now, the S&P 500 SPX sits about 3.5% from its highs.

-Steve Goldstein

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