My thesis from the very start of the year was clear. We would see a melt-up (due to pre-election year dynamics) that would end in a corporate credit event. The CBOE Volatility Index (VIX) would spike, credit spreads would widen, and stocks would break the October lows of last year, marking the end of the bear market.

Why? Because of the lagged effects of the fastest rate hiking cycle in history.

We went through a top-20 drawdown in large-cap stocks and for the first time in history, long-duration Treasurys were down more than the S&P 500 in a top-20 decline.

The S&P 500 is now close to touching its nominal all-time highs, which would invalidate the thesis as it locks in that drawdown period. In other words, maybe that was the exception – the one time in history in a major decline for the S&P 500 where Treasurys did indeed fail to be the better place to be relative to the stock market.

Or maybe not

If we look at the same top-20 drawdown chart with the Russell 2000 index, we see the same dynamic with small-cap stocks, which unlike large-cap stocks, are nowhere near their prior 2021 high.

The Bottom Line on a 2023 Credit Event

Here’s the point. Clearly, I was wrong that a credit event would happen this year. Yes – I’m the first one to say that “the year isn’t over,” but the fact that it does look like the S&P 500 wants to break nominal all-time highs, in fairness, breaks the original argument.

Of course, we could still have a credit event with spreads blowing out, but that would be the start of a new drawdown period for the S&P 500.

What remains to be seen is how small-cap stocks interact now with the thesis. One could argue that this year has been such an anomaly with the Magnificent 7 dynamic that the small cap/Treasury drawdown interplay is the only one to look at. I don’t think this is unreasonable by any means. And this isn’t me “moving goal posts.” What has been missing in this cycle is widening credit spreads, and bankruptcies tend to lead that behavior. It’s simply then a question of timing. I flagged October-November as high risk, and it turns out, October was instead the low.

That’s okay. The delays might still hit in a sudden way. Either way, for the full thesis to be invalidated, it’s clear that small-cap stocks hold the key.

On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.