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Need to Know: Here’s the incredibly strong signal for stocks that is coming from the corporate bond market

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Is it a false dawn in the stock market or is there something real? The S&P 500 has never lost ground over the following year when advancing volume was at least 85% of volume for two out of three days coming off a 52-week low, according to Jason Goepfert, the founder of Sundial Capital Research. That has happened 13 times.

Here’s another: The S&P 500
SPX,
+0.59%

closed higher on Wednesday for the first time since March after a day in which it gained at least 2%. You can now buy the dip without automatically and instantly getting punished.

But our call of the day studies the link between the corporate bond and stock markets. Spreads in both investment grade and riskier high-yield bonds have narrowed rapidly over the last three weeks.

Analysts at Bespoke Investment Group studied the history of such spread compression, though it isn’t a long series since the popular credit-default swap indexes were only invented this century.

Bespoke Investment Group

The signal is incredibly strong on the junk-bond side. In the nine previous times when the CDX HY spreads fell at least 75 basis points in three weeks, the S&P 500 rose over the next week, six months, and year, with 22% average returns over the next year. “It’s awfully hard to come up with a market signal that looks much better than that long-term,” said the Bespoke analysts.

On investment-grade bonds, it is less strong but still positive. When the CDX IG spread has fallen at least 15 basis points over three weeks, and that has happened 14 times since 2005, the S&P 500 rose in a year’s time in 12 of those occasions, with an average gain of 13%.

A word of warning, however. At current pricing, junk bonds
JNK,
+0.50%

aren’t pricing in a recession, according to BCA Research. The index is pricing in a default rate of 6.65%. “Given that default rates typically surpass 8% during recessions, there is scope for spreads to widen further if recessionary risks intensify,” said the BCA analysts.

The buzz

Tesla
TSLA,
+0.80%

reported earnings above expectations and managed to be cash flow positive for the quarter by selling 75% of its bitcoin
BTCUSD,
-2.68%

holdings, at a loss. The electric-vehicle maker also said it plans to begin long-delayed Cybertruck shipments in the middle of next year. Ford
F,
+1.11%
,
meanwhile, is going to cut thousands of jobs to refocus on EVs, The Wall Street Journal and Bloomberg News reported.

Aluminum producer Alcoa
AA,
+0.36%

and casino operator Las Vegas Sands.
LVS,
+4.36%

rallied after stronger-than-forecast results. United Airlines
UAL,
+0.51%

missed on earnings and reduced its capacity plans for next year. Cruise operator Carnival
CCL,
+7.05%

plunged 12% after selling $1 billion in stock.

The European Central Bank made its first rate hike in a decade with a half-point increase, somewhat surprising the market and giving the euro
EURUSD,
+0.53%

and bund yields
TMBMKDE-02Y,
0.745%

a lift. It also approved what it’s calling the Transmission Protection Instrument, to limit bond yields spreads in the eurozone. 

U.S. jobless claims rose 7,000 to 251,000, as the Philadelphia Fed manufacturing index moved deeper into negative territory with a -12.3 reading.

Italy’s Prime Minister Mario Draghi resigned, throwing the eurozone’s third-largest economy into political turmoil and sending Italian bond yields higher.

Russia’s Gazprom resumed sending gas to Germany through the Nord Stream 1 pipeline at the same 40% rate it did before the planned maintenance period. Russia also said it is planning annexation votes in Ukraine regions by Sept. 15. Ukraine devalued its currency, the hryvnia, by 25% against the U.S. dollar.

The market

U.S. stock futures
ES00,
+0.21%

NQ00,
+0.48%

were pointing to a muted start. Crude-oil futures
CL.1,
-3.73%

tumbled, losing about $4 per barrel. The yield on the 10-year Treasury
TMUBMUSD10Y,
3.042%

rose to 3.05%.

Top tickers

Here were the most active stock-market tickers as of 6 a.m. Eastern.

Ticker

Security name

TSLA,
+0.80%

Tesla

GME,
+4.65%

GameStop

AMC,
+7.09%

AMC Entertainment

XELA,
+14.34%

Exela Technologies

FAZE,
-24.12%

FaZe Holdings

NIO,
+0.84%

NIO

AAPL,
+1.35%

Apple

AMZN,
+3.86%

Amazon.com

NVDA,
+4.80%

Nvidia

NFLX,
+7.35%

Netflix

Random reads

General Motors
GM,
+1.05%

wants to test a self-driving car without a steering wheel or pedals.

A possible Fabergé egg was recovered on a seized Russian oligarch’s yacht.

This bride had to hitchhike to her own wedding.

Need to Know starts early and is updated until the opening bell, but sign up here to get it delivered once to your email box. The emailed version will be sent out at about 7:30 a.m. Eastern.

Want more for the day ahead? Sign up for The Barron’s Daily, a morning briefing for investors, including exclusive commentary from Barron’s and MarketWatch writers.

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