As you can see, credit spreads narrowed significantly in 2009 after the passing of the financial crisis. These spreads widened twice during the current economic expansion: in late 2011 and in late 2014 through early 2016, the two intra-cycle "resets" mentioned earlier. As spreads have started to widen again over the last two months, we revisited the two previous episodes for clues on the current environment.
2011 was marked by fears of Greece leaving the European Union, the related European debt crisis, and the S&P downgrade of US debt. Talk of a double dip recession was common, and volatility in the equity markets increased.
Late 2014 through early 2016 saw oil prices collapse, decreasing over 50%. China devalued its currency, investors had serious concerns about the growth outlook, and volatility again increased.
The current spike in volatility has commonalities with both previous intra-cycle resets. Oil is down over 30%. Macro concerns dominate the news wires with trade relations between the US and China at the forefront. Also, each episode included consternation of the Federal Reserve's next move.
The main difference between the two earlier periods and now is the lack of support from global central banks. In 2011, central banks were still undergoing an asset purchasing program known as quantitative easing to support financial markets as they recovered from the financial crisis. In 2015, the Fed had not begun raising rates, and other global central banks continued to pursue quantitative easing. Today the Fed is raising rates and quantitative easing has ended.
In each of the previous bouts of volatility, the macro clouds cleared, growth resumed, and the equity markets reacted positively. Are we set to repeat this pattern again or are we finally headed for the next recession? The outcome is far from guaranteed, but at this point it appears we are more likely than not to find a resolution to the current growth scare in a similar manner to the last two. Economic data remains solid, highlighted by employment growth, wage growth, and consumer spending. Admittedly, trade negotiations between the US and China are difficult to predict, but I do believe it is in both sides' best interests to find common ground. Both administrations want to avoid a recession and both are keenly aware of movements in the financial markets. In addition, the Fed has hinted strongly that the pace of interest rate increases is set to slow.
Pullbacks in the equity markets naturally make stocks less expensive, and can create opportunities. As you can see below, stock valuations (as measured by trailing price to earnings multiples) have become much more reasonable and returned to the level last seen during the bout of volatility in 2015 and early 2016.