High Yield Spread Signaling Recession
One of the many indicators that we watch in our universe is the spread, or the difference, between interest rates on bonds. If an issuer is of high quality then the interest rate charged to borrow money will be lower than a comparable loan with a higher risk borrower. When the economy is doing well more lenders are willing to provide money to high risk creditors. The abundance of monetary supply leads to lower interest rates charged by lenders to risky borrowers. When the economy is in trouble lenders tend reduce risky loans and charge higher rates for money. The difference between, the spread, what lenders are willing to charge for loans between high and low risk borrowers can provide information as to the perceived risks in the economy.
One of the most recent indicators that the weakness in the economy is spreading is that the spread between loan types is widening and has now reached a level that has been mostly associated with recessions in the past. As the economy weakens lenders are beginning to charge more to borrowers with higher repayment risks. Remember, the term "High Yield" is fancy name for "Junk Bonds" and when the demand of high yield bonds is high; yields are low.
The previous certainty about economic recovery is now wearing thin and the higher borrowing costs will extract much needed capital out of the economy. This will further impede economic growth by reducing capital investment and hiring. This is just one data point, however, it is one when combined with so many others as of late should be raising your defensive stance.