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METHODOLOGY · INDICATOR

Leverage & Credit

Debt is the accelerant. Credit spreads are the smoke detector.
WEIGHT
20%

WHAT WE MEASURE

Leverage & Credit measures how much systemic debt is embedded in the financial system, and how the credit market is pricing the probability of defaults and stress. Credit markets are typically smarter and more forward-looking than equity markets: they sense trouble before stock prices reflect it. When spreads widen, it means lenders are demanding more compensation for risk they are beginning to see.

WHY IT MATTERS FOR BUBBLE DETECTION

Almost every major financial crisis in history was preceded by a credit bubble. Irving Fisher's Debt-Deflation Theory (1933) described the self-reinforcing spiral: falling asset prices trigger margin calls, forced selling drives prices lower, which triggers more margin calls. Credit spreads are the earliest warning because the bond market prices defaults before equity investors acknowledge them.
High Yield and Investment Grade credit spreads are normalised against their 20-year history. Margin debt as a percentage of GDP is tracked for systemic leverage. Each component is scored 0–100 and combined to produce the Leverage & Credit category score, which contributes 20% of the composite.

KEY METRICS & THRESHOLDS

High Yield (HY) OAS
The Option-Adjusted Spread of the ICE BofA US High Yield Index: the extra yield "junk" bonds pay above equivalent Treasuries. When HY spreads widen sharply, it signals credit stress and that lenders are pulling back from risky borrowers. This typically leads equity market stress by 4–12 weeks.
SOURCE: ICE BofA Index (FRED: BAMLH0A0HYM2)
Tight (Risk-On)
< 300bps
Normal
300 – 450bps
Elevated
450 – 650bps
Stress
650 – 900bps
Crisis
> 900bps
Investment Grade (IG) Spread
The extra yield investment-grade corporate bonds pay above Treasuries. IG spreads are less volatile than HY but serve as an important cross-check: when even high-quality borrowers see spreads widen significantly, systemic stress is broad-based.
SOURCE: ICE BofA IG Index (FRED: BAMLC0A0CM)
Tight
< 80bps
Normal
80 – 150bps
Elevated
150 – 250bps
Stress
250 – 400bps
Crisis
> 400bps
Margin Debt / GDP
Total margin debt outstanding (money borrowed from brokers to buy securities) as a percentage of GDP. When leverage is high and markets fall, margin calls create forced selling, which drives prices lower and triggers more margin calls: a self-reinforcing spiral described by Hyman Minsky.
SOURCE: FINRA Monthly Margin Statistics; BEA GDP
Low Leverage
< 1.5% GDP
Normal
1.5 – 2.5% GDP
Elevated
2.5 – 3.5% GDP
High Risk
> 3.5% GDP

HISTORICAL EPISODES

2007 – 2008
Global Financial Crisis
SIGNAL
HY spreads rose from 250bps to 2,000bps over 18 months
OUTCOME
S&P 500 fell 57%; global credit markets froze
Sep 2008
Lehman Collapse
SIGNAL
TED Spread hit 460bps; overnight funding markets seized
OUTCOME
Worst financial crisis since 1929
Mar 2020
COVID Crash
SIGNAL
HY spreads hit 1,100bps in 3 weeks
OUTCOME
S&P 500 fell 34% in 33 days; Fed intervened at record speed
2022
Rate Shock Bear Market
SIGNAL
HY spreads reached 600bps as Fed hiked 425bps in 12 months
OUTCOME
S&P 500 fell 25%; bond market worst year in 100+ years

HOW TO INTERPRET THE SCORE

Low Stress
0 – 25
Credit is flowing freely. Spreads are tight, leverage is contained.
Moderate
25 – 50
Spreads drifting wider. Leverage building. Warrants monitoring.
Stressed
50 – 75
Credit tightening visibly. Lenders pulling back. Equity markets typically follow within weeks.
Crisis Territory
75 – 100
System-wide credit stress. Consistent with 2008 or 2020-level dislocations.

ACADEMIC & INDUSTRY SOURCES

[1]
Fisher, I.: The Debt-Deflation Theory of Great Depressions1933
[2]
Minsky, H.: Stabilizing an Unstable Economy1986
[3]
Borio, C. & Lowe, P.: Asset Prices, Financial and Monetary Stability: Exploring the Nexus (BIS)2002
[4]
Reinhart, C. & Rogoff, K.: This Time Is Different: Eight Centuries of Financial Folly2009