×

This obscure market is pointing to more pain for stocks

A little-followed corner of the credit markets could be signaling more trouble for stocks.

According to Larry McDonald of Societe Generale, bets against Asian bonds have been rising over the past month in countries including South Korea, Vietnam and Thailand. And if history is any indication, that could mean more pain for equities.

"As equities have bounced here this week, the cost of default insurance in Asia on corporations, banks as well as countries is still very, very elevated, which tells us that these equity rallies aren't to be trusted," McDonald said Thursday on CNBC's "Trading Nation."

According to McDonald, deterioration in the Asian credit markets actually started before the recent bout of selling in U.S. equities, and has been a reliable indicator for where they are heading.

"We actually saw Asian credits significantly deteriorate almost a week before we had the big selloff here," he said.

And by his work, those markets have yet to respond to the rally in U.S. stocks.

"Asian credits did not improve with the equity bounce here," said McDonald. "To me that's bearish."

Specifically, McDonald is looking at the cost of so-called credit default swaps, or CDS, on Asian corporate and sovereign debt. A CDS contract acts as protection against nonpayment or default on a security. Increased buying of CDS contracts in these countries could imply that investors are more nervous about the risk of default in Asia.

However, some investors said the stock selloff could also be gauged by credit risk closer to home.

Albert Brenner, director of asset allocation strategy at People's United Wealth Management, pointed to a decline in prices for corporate and high-yield bond prices.

"The fallout in stocks was in some way anticipated by rising spreads in the bond market, not in the Treasurys side, but on the corporate side, both in high-yield and investment grade," Brenner said Wednesday on "Trading Nation."

Read More Why bonds aren't rallying amid the stock selloff

For Neil Azous of Rareview Macro, credit spreads in the U.S. are a much better indicator of domestic economic and financial stress.

"The United States is much more of a closed economy, and their exposure to Asia specifically China is very limited," Azous said in a phone interview. "The correlation of an Asian credit spread to the U.S. stock market is historically much lower."

Want to be a part of the Trading Nation? If you'd like to call into our live Wednesday show, email your name, number, and a question to TradingNation@cnbc.com

Videos

Trades to Watch

Trader Bios

About

Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Brian Sullivan

Brian Sullivan is co-anchor of CNBC's "Power Lunch" (M-F,1PM-3PM ET), one of the network's longest running programs, as well as the host of the daily investing program "Trading Nation." He is also a frequent guest on MSNBC's "Morning Joe" and other NBC properties.

Read more

Connect