Want to know where the S&P; 500 (SPY) is headed? The corporate bond market likely holds the answer.

So far this year, investment grade debt sales are on a record pace according to the article Blackstone Group to Sell Debt as Investment-Grade Spreads Widen.

Bloommberg notes that Blackstone (BX) joined Microsoft Corp. (MSFT), the world’s largest software maker, in making a debut offer this year and that investment-grade debt sales of $774 billion are on pace to reach a record.

Meanwhile yield spreads on corporate debt vs. treasuries have declined from 603 basis points on Jan. 2, to 254 basis points today according to Merrill Lynch & Co.’s U.S. Corporate Master index.

Access To Debt Markets Keeps Zombie Corporations Alive

Ability to raise cash now will keep many zombie corporations alive. GM went under when its borrowing dried up. Ford (F) stayed in business because it had a bigger pile of cash relative to its burn rate.

Thus it’s no wonder that stocks are rallying in the face of record demand for debt, demand that has dramatically reduced long term corporate borrowing costs.

“Liquidity is the name of the game for financial-related firms,” said Guy Lebas, chief economist and fixed-income strategist with Janney Montgomery Scott LLC. “Many issuers as well as buyers realize that the improvement we’ve had in spreads over the last eight weeks marks the final step in the credit rally for 2009.”

23 Day Rally In Corporates

The question now is where to from here? The article notes the investment grade bond rally lasted 23 consecutive days, ending two days ago. The widening today is a statistically irrelevant 1 basis point.

Evidence of a pullback is more readily apparent in junk bonds.

Yields on high-yield, high-risk, bonds relative to benchmark rates widened 14 basis points yesterday to 878 basis points, the third straight day of increases after 16 consecutive days of tightening, according to Merrill Lynch & Co’s U.S. High-Yield Master II index. High-yield notes are rated below BBB- by Standard & Poor’s and less than Baa3 by Moody’s Investors Service.

S&P; 500 During Corporate Bond Rally

click on chart for sharper image

Keep an Eye on Bonds!

As long as corporate bonds fetch a good bid, which in turn allows companies to raise cash at decreasing costs, the stock market is likely to be reasonably firm. Note that the pullback in junk bonds began 3 days ago on that last red candle.

I am skeptical the rally in bonds can last much longer, but until the corporate bond market starts showing increased signs of stress, equity bears expecting huge pullbacks are likely to be disappointed.

Either way, it will pay to keep one eye on the credit markets to help ascertain long-term equity direction. In August of 2007 the corporate bond market cracked wide open. Although the S&P; 500 made a new high in November, the corporate bond market didn’t. It was the mother of all warning calls that most missed.

Mike “Mish” Shedlock
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