Repeats for early U.S. readership, no change to text.

By Mike Dolan

LONDON, March 6 (Reuters) - Trouble on Main Street usually means trouble on Wall Street - and not just top-line stock prices.

If a rare U.S. economic downturn is indeed back in the mix, with business bamboozled by trade wars and government disruption, then the full gamut of financial market activity and pricing faces a shakeup.

U.S. equities with 35% valuation premiums to Europe, for example, have already felt some of the heat as tensions have risen and economic models flash red.

But the world of corporate credit - particularly the riskier "junk bond" universe of sub-investment grade debt - is usually where you'd seek a reality check on recession fears.

While economic worries typically cut Treasury yields and base borrowing costs, speculative high-yield debt is prone to any uptick in recession risk that almost always tallies with higher bankruptcy and default risks for weaker credit.

And there's been some wobble there over recent weeks to mirror the equity fright of the past month.

The options-adjusted risk spread on ICE Bank of America's high-yield U.S. credit index .MERH0A0 over Treasuries has risen almost 40 basis points in just two weeks - from near historic lows to its widest since October at just under 300 bps.

To be fair, this remains extraordinarily benign pricing, with default rates for the grouping expected to remain historically low this year at about 2.5%. And at 300bps, the junk spread is still a sliver below the average of the past year and over a percentage point tighter than the five-year average.

But like the equity market itself, it's been largely priced for a serene scenario of no economic downturn whatsoever over the horizon - and may need a rethink if those probabilities at least are now rising again as many suspect.

Morgan Stanley's strategists think the broad investment grade and low grade credit markets have held up reasonably well so far over recent weeks but said they were "cautious" about what happens next.

"We are worried this won't persist if our U.S. growth estimates fall further," Andrew Sheets and team told clients. "We look for opportunities to hedge and improve quality."

DEALS STALL

Somewhat counterintuitively, credit prices have been helped by stalling U.S. deals activity this year. Credit risk tends to correlate with ebbs and flows in mergers and acquisitions as the related debt financing goes hand in hand.

But the main reason for the drop in M&A this year is hardly cause for comfort for the underlying credits.

According to Reuters reports, Wall Street executives and investors are running into roadblocks to get deals over the finish line or even to begin exploratory talks - mainly because of the fog over government policy and its impact on the economy.

M&A in the first two months of 2025 was the weakest since the financial crisis with just 1,603 deals signed through February, making it the slowest open by volume since 2009, Dealogic data showed.

Total deals fell more than 19%, while the total value dropped 29% to $249 billion from the first two months of 2024.

Even if you need to brace for "a little disturbance", as President Donald Trump described it on Tuesday, you could possibly cheer yourself with a readout from the most recent U.S. earnings season. After all, that showed 17% annual profit growth for S&P 500 firms through the end of last year.

But this too may be misleading as a measure of overall corporate health and other wider cuts of company updates beyond the blue chips show a far more fragile picture - one not best prepared for a significant bout of trade and macro turbulence.

And it's in here the recently "perfect" equity and credit pricing looks way off if a sharp slowdown is underway.

FRAGILE UNDER THE SURFACE

Societe Generale's Andrew Lapthorne points out that if you take the wide S&P 1500 .SPSUP index and exclude financial stocks but include the biggest 10% of companies that dominate market cap weightings, the picture looks healthy on the surface. Profit growth of 10% shows little reason to fret.

But if you exclude the top 10% of big caps from this ex-financials cut of the index, the remaining 1,000 or so firms in the index on aggregate saw no earnings growth over the past 12 months at all. What's more, their net income and sales growth was actually negative.

Hand-wringing about "over-concentration" of the U.S. stock market is not new of course. But it becomes more salient if the tide on Big Tech themes like artificial intelligence has hit a high watermark.

And if what's coming down the pike amounts to a macro shock, corporate America and Wall Street have good reason to worry.

The opinions expressed here are those of the author, a columnist for Reuters

(By Mike Dolan; Editing by Sam Holmes)

((mike.dolan@thomsonreuters.com; +44 207 542 8488; Reuters Messaging: mike.dolan.reuters.com@thomsonreuters.net/))