Katie Stockton's Three Warning Signs, and Why Credit Spreads Matter Most

Is this a dip or the start of something worse? Every portfolio manager is asking it right now. Fairlead Strategies founder Katie Stockton has a fairly specific answer, and it doesn't start with the chart of the S&. P 500.

Breadth Is Already Broken

The numbers tell the story. Only 21% of stocks are trading above their 50-day moving average. That matches the March low, and March was ugly.

Stockton sees support intact. She also suspects last Friday marked a short-term low for semiconductors. But she calls the overall setup somewhat fragile, which is a polite way of saying the index is being held up by a handful of names.

A cap-weighted index can look calm while the average stock bleeds. That gap is the whole story here.

Credit Spreads Are the Real Tell

Here's what matters: the first of Stockton's three warning signs is wider credit spreads.

That's the right place to look. Equity investors own a residual claim on cash flows. Bondholders own a senior one. When high yield spreads start to widen, the people first in line for the money are getting nervous. Equity multiples follow that signal with a lag. Frankly, they've to. You can't price a growth stock off earnings the bond market is already discounting.

Credit has been well behaved through this pullback. Investment grade is fine. High yield is fine. That's the strongest argument that this is a correction, not a regime change.

The Narrow Rally Problem

The other two signs sit in the same neighborhood. Breadth that keeps deteriorating without stabilizing, and momentum that rolls over even while the index holds. A rally carried by a few mega caps can persist for weeks. It just can't broaden on its own.

According to Stockton, the burden of proof sits with the bulls. That's a fair read. When 79% of stocks are below their 50-day average, the index isn't telling you much about the average portfolio. A manager running equal-weight exposure is having a very different year than the headline suggests.

So how fragile is fragile? Watch what happens on the next retest of support. If breadth improves on the bounce, the low is in. If it doesn't, the March comparison stops being a coincidence.

What to Watch Next

Three things, in order of importance.

First, high yield spreads. A decisive move wider without a matching move in equities is the tell. Second, the weekly breadth reading. A push back above 40% would ease a lot of this. Third, semis. Stockton's call that Friday marked a short-term low for chips needs confirmation, not hope.

Then add the next inflation print and the Fed decision that follows it. Those are the catalysts that either validate the credit market's calm or break it.

From a risk perspective, this argues for trimming position sizes, not dumping exposure. Support is still support. But conviction should be lower now than it was a month ago, and anyone pretending otherwise isn't watching the same tape.