By Jacob Sonenshine
All three major U.S. stock indexes finished in the red Tuesday, as the war in the Middle East intensified. Stock market volatility was driven by worries about the oil supply and inflation concerns.
Meanwhile, the bond market was sending its own ominous signal, in the form of credit spreads.
Those spreads represent the difference in yield that investors demand to hold riskier corporate and mortgage bonds instead of U.S. Treasuries. The higher the spread, the more the bond market sees companies and people having trouble repaying their debts -- and the spreads have been widening. That's potentially bad news for stocks.
Spreads for an aggregation of 10 year investment grade U.S. bonds have risen to 0.86% from a 2026 low of 0.73% in late January, according to St. Louis Fed data. Driving them higher is not only war in the Middle East, but also what has been persistent news flow about private credit funds seeing deterioration to the assets they hold, causing markets consternation about corporate credit.
Now, it looks like spreads could stay fairly high -- or widen further. The high 0.8% area is where spreads have consistently peaked and then dropped since June 2025, but right now, they're flirting with breaking above that level.
If they do, it opens the door to a more distinct possibility of a jump to over 1%, which it topped in April last year when President Donald Trump introduced tariffs that the market thought would crush the economy.
The takeaway: while spreads aren't flashing red yet, they're dangerously close. Credit markets are at "yellow flag" levels, writes Evercore strategist Julian Emanuel.
If they cross into red territory, stock investors should watch out. The key is that equity valuations are lower when the the cost for companies to borrow rises. A company's financial profile becomes riskier, which makes the equity worth less. That's why stocks' multiples of expected earnings drop when spreads rise.
In fact, our analysis of FactSet and St. Louis Fed data prove the point. If spreads rise to the 1.21% level they peaked at in April 2025, the S&P 500's forward price/earnings multiple would drop to about 18.8 times from its current 21.6 times.
If that happens in short order -- the catalyst could be anything from a private credit fund blowing up to a worsening Iran situation -- it would represent a roughly 13% drop in the S&P 500. Don't be surprised at that: when spreads jumped from a bit below 1% to that peak in April last year, the S&P 500's total drop from peak to bottom was 19%. Much like then, today's economic landscape features some changes that could scare the market and reduce equity valuations.
Think about it this way: higher credit spreads mean the market is becoming more uncertain about a company's profits, and "uncertainty should be bad for [stock] multiples," writes Trivariate Research's Adam Parker, who says the S&P 500 is more likely to see multiples drop than rise from here.
The point is that the stock market could easily see a "correction," or a 10% or greater drop from its peak. Be patient about buying stocks for the moment.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
March 03, 2026 16:32 ET (21:32 GMT)
Copyright (c) 2026 Dow Jones & Company, Inc.
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