The area of the bond market that was flashing warnings about potential equity market volatility and weakness was the most equity-like area of the bond market, the high yield (junk) debt market.

Credits spreads of B-rated U.S. Corp. Bonds vs. UST benchmarks since 9/15 (Source: BAML):

S&P 500 index since 9/15 (Source: Bloomberg):

Russell 2000 Small-cap equity index since 9/15 (Source: Bloomberg):

As you can see by the above charts, by early November, the credit markets began sending out warning signs, but the equity markets were ignoring these signs, caught up in the spirit of hope and an expectation of a so-called year-end Santa Claus rally, which did not materialize. What has happened since just after Thanksgiving is the equity market has played catchup to the corporate credit (bond) market.

Each and every day, investors, advisors and financial media pundits ask: When will we see a bottom to the equity market decline? In my opinion, that will probably not occur until the high yield bond market bottoms. I do not think that will happen until we see corporate defaults tick higher. My guess is that if and when corporate credit defaults rise to about a 6.0% default rate, from a 3.0% default rate in 2015, we could find a bottom in the high yield debt market. That probably does not happen prior to mid-2016.

This does not mean we cannot or will not see rallies from time to time, in both the equity and (to a lesser extent) in the corporate credit markets. However, until a firm bottom is established, I am of the opinion that it is better (where suitable and appropriate) to sell the “rips” rather than buy the “dips.” However, long-term investors may wish to wade into the markets gradually on weakness. I believe we can reverse that strategy sometime in the second half of 2016 or early 2017. However, be prepared for much volatility in the interim.