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U.S. credit markets are absurdly overbought and equity investors on both sides of the border will be very much in the way of the inevitable correction when it occurs.

The most common method of gauging whether corporate debt is attractive or expensive is the spread – the difference in yield between a corporate bond issue and a government bond issue of the same maturity. When the spread is low, it is more difficult for investors to generate returns and there is less margin of safety.

The accompanying chart shows that the spread on the riskiest form of corporate debt – high yield bonds – are trading at spreads very close to the pre-2007 lows. At the same time, the CBOE Volatility Index – which uses equity option prices to measure expected volatility and market risk – is hitting all time lows. In other words, debt markets are expensive, and investors are broadly complacent.

Market insiders are well aware that things are getting out of hand in credit markets, with corporate yields barely above U.S. Treasuries. John Jansen, now retired after a 34-year career as a debt trader, notes the current 25-basis-point spread over Treasuries for triple-A rated corporate bonds and writes, "It is crazy but there is no end in sight to the lunacy."

New River Investments LLC hedge fund manager Guillermo Roditi Dominguez's exasperation with current prices was evident on Twitter last week (where insiders can be particularly blunt on this issue) after a Walt Disney Co. three-year bond was issued: "just saw the disney bond. 20 over [treasuries]. twenty. time to pack it up and go hit the pool. i aint abuyin no more bonds this year [sic]."

Expensive is one thing but expensive with leverage is another, far more dangerous thing.

The search for yield and wanton ignorance of market risk has even led to the exhumation of collateralized loan obligation (CLO) structure – the leveraged products that helped almost blow up the entire financial system in 2007 and 2008.

A Forbes report noted "collateralized loan obligation issuance for the [year-to-date at] $34.5-billion [U.S.], ahead of the $30.2-billion seen at this point in 2013. For the full-year 2013, of course, there was a record $82.61-billion in CLO issuance."

There's no telling when, how violently, or what the catalyst will be, but credit spreads will almost assuredly widen from current levels. Importantly, equity investors that do not directly hold corporate bonds will be negatively affected when this happens.

Tight credit spreads represent risk for bond investors but, by lowering corporate borrowing costs, have been hugely beneficial for equity market profits. They have allowed chief financial officers to refinance existing debt at lower rates, lowering interest costs.

Cheap money from investors has also allowed companies to fund mergers and acquisitions and buy back stock. The latter increases earnings per share. Low borrowing costs have been the primary method for companies to maintain profit growth despite limited revenue increases.

The trend will work in reverse as spreads widen – higher interest costs, fewer buybacks and also declining merger and acquisition activity.

The credit correction may not be imminent and this offers investors a chance to prepare their portfolios. The obvious thing to do sell direct exposure to corporate debt issues and avoid structured credit products at all costs.

Less obvious, but still important, is to reduce equity holdings in sectors such as telecom, utilities and real estate investment trusts that routinely carry a lot of debt. Their borrowing costs will steadily rise.

Follow Scott Barlow on Twitter at @SBarlow_ROB.