QQQ - Defining The Credit Event That Could Come This September

2023-08-29 12:10:24 ET

Summary

• A credit event refers to a sudden increase in credit spreads and default risk, leading to a negative shift in a borrower's ability to meet payment obligations.
• The effects of a credit event can ripple through the financial ecosystem, impacting investor sentiment, stock market performance, and the overall economic climate.
• The current complacency in the debt markets and the massive corporate debt overhang pose a significant risk of a credit event in the future.

"Taking risks doesn't mean shirking responsibility, but embracing possibilities." - Vick Hope.

I've been hammering the idea that the risk is very real that we may be on the verge of a credit event, writing about the potential for "Nouveaux Bulls" to get badly surprised, and maintain the idea that investors are massively underestimating how the lagged effects of the fastest rate hike cycle in history will actually factor into the economy and broader stock market (SP500). I've had some people ask me what a "credit event" is, and it's actually very simple - it's a VIX spike where credit spreads widen aggressively. Default risk rises, crash risks increase, and capitulation then occurs in risk-on assets. If we look at the VIX against credit spreads, we see a pretty tight relationship historically.

What does a credit event mean in practice when it comes to the real economy and the mechanics of how it impacts companies? Put simply, a credit event suggests a sudden and substantial negative shift in a borrower's ability to meet payment obligations. We are already seeing this in the real economy. Bankruptcies are factually rising consistent with prior periods of broader market stress.

The effects of a credit event are not confined to the immediate parties involved. The repercussions can ripple through the financial ecosystem, influencing investor sentiment, stock market performance, and the overall economic climate. To think conditions don't favor it in the future to me is foolish. In the next couple of years, corporations will need to roll over trillions of dollars of debt. This looming debt burden creates a precarious situation, as these corporations' ability to refinance their obligations hinges on the health of the credit markets. If the credit market tightens or investor sentiment sours, refinancing could become challenging, leading to an increased risk of default.

I'm actually blown away by current complacency in the debt markets, potentially exacerbating the potential for a credit event. Investors are not sufficiently factoring in the risk associated with the massive corporate debt overhang in the post-Covid period against higher for longer rates. To think that this wouldn't impact AI mania, and the broader stock market, is completely counter to history. The bond market is far larger and more consequential than stocks. The stock market would not be immune to these developments. As fear spikes, stocks typically fall significantly. This relationship is due to increased uncertainty and risk aversion among investors, leading to higher volatility and selling pressure in the stock markets. And hopefully the return of the flight-to-safety trade, which candidly I need for my own approach to positioning in my various strategies.

The possibility of a credit event is a substantial risk that investors and market participants must stay vigilant about. While it's impossible to predict exactly when such an event might happen, being prepared and understanding the potential implications can help mitigate the impact. I do think September is a very high-risk month given seasonality and again the lagged effects of rates hitting right around now. Bottom line? A credit event is perfectly natural, and not something to fear - just something to be aware of and one that could blindside us all on timing.

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