On August 17th and again on September 1st the SPX dropped 26 points and 24.50 points respectively. Leading up to 8/17 CDS spreads had risen from 105bps to 123bps (18bps or 17%) on the investment grade index in what can easily be called an uninterrupted run. From 8/27 to 9/2 the investment grade CDX index moved up 9bps or another 7%.
Empirical studies have shown a negative correlation between CDS spread movement and equity price movement so making higher highs and higher lows in the investment grade CDX index does not jive with higher highs and higher lows in the SPX. But that is what is happening.
On an individual name basis there are periods of time when the CDS/equity relationship decouples from its usual negatively correlated manner but these are easy to deal with when the universe of names being followed tops the 400 mark because there are more than enough other instances in other names where things are working according to plan to establish positions.
When the indices begin to exhibit this departure it is truly something to note but also something to be extremely wary of.
The pundits, some having now been caught by the last waves of the high tide, are changing from über bears to bear cubs and in a few cases might even be changing species and growing nascent nubs if not horns in the process.
I have not seen the CDS/equity relationship decouple on an index basis in the six years since I have been watching these two markets but it should also be noted that the ability to view the interaction of CDS spreads and equity prices, at least on the index level, was not available when I first started observing this relationship in 2003.
It is the beginning of September; the start of what is usually the toughest two-month stretch the stock market has on an annual basis. The experts have been calling this a bear market rally. CDS spreads made a new high on Tuesday by 1bp but stayed below the one day correction level of 125bps set back on 7/22 when CDS spreads were falling like a pebble through water.
Labor Day weekend is upon us but by all counts the holiday is late this year. Volume was noticeably higher during the selloff on Monday but the creep up since then doesn’t even qualify as any kind of confirmation move.
Summer is over. Maybe after the Monday holiday things will get back to some version of normal. Maybe abnormal is the new normal.
