The Panic Button is being pressed

Analysts Notebook wrote a column · May 16, 2022 04:59

• Panic indicator is an indicator of stress in credit markets has spiked to a high - but not yet extreme level.

• If it goes much higher, it will have negative implications until it spikes to truly extreme levels.

• As it stands, it's a modest positive for stock returns and higher-beta factors.

The Panic Button indicator, which monitors a handful of stress-related indicators in credit markets, has risen above 1.0, a high level. As long as it stays relatively low, prospects for stocks are okay. Bulls just don't want to reach a modestly higher level, unless it skyrockets to an extreme that would indicate all-out panic.

Source: S&P,CBOE,U.S.Treasury,Bloomberg

Investors truly started to panic last week. In March, despite losses in stocks, credit conditions were relatively calm. The biggest panics - not grinding bear markets, but actual panics - always see wholesale selling pressure in credit markets.

Panic Button has been pressed. The panic indicator has risen above 1.0 for the first time in almost two years.

The panic indicator incorporates the TED Spread, Junk Bond Yield Spreads, a ratio of Volatility to 3-Month Treasury Bill Yields, and High-Yield CDS Spreads. These spikes higher when uncertainty about the economy, corporate outlooks, and stock prices are high. They reach extreme levels only during times of outright panic across markets.

As long as the Panic Button remains below 1.5, the outlook is decent

Returns have been very good when it is between 1.0 and 1.5. When it gets between 1.5 and 3, returns tend to suffer.

The table below shows the $S&P 500 Index(.SPX.US)$'s returns when the indicator rises above 1.0. There was often some volatility in the short term, and five of the last six signals saw negative returns in the first couple of weeks. But over the next few months, conditions stabilized, and eight of the last nine signals saw a positive return. The sole loser was small.

Source: Sentimentrader

A return to risk-seeking behavior?

Most sectors saw some shorter-term weakness following these rises in the Panic Button, but most didn't last long. There was a curious mix with the best longer-term returns, including Industrials, Technology, and Health Care. Energy and Utilities brought up the rear.