Bonds Are Confirming The Risk Appetite For Stocks

Today we are looking at a ratio chart of High Yield Junk Bonds vs Investment Grade Bonds. The vehicles we are using to compare are the Markit iBoxx USD Liquid High Yield Index Fund ($HYG) vs the Markit iBoxx USD Liquid Investment Grade Index Fund ($LQD). Earlier this year, the ratio completed its multi-year downtrend when it fell to support from March of 2009. If you recall, this was the bottom in the S&P500 after the historic 2008 crash:

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After finding a bottom in February this year, the ratio has been consolidating in a sideways range between two converging trendlines. Last month, however, the ratio broke out above the upper of these two trendlines confirming the new all-time highs we’re seeing in the S&P500, Dow Jones Industrial Average and Nasdaq Composite.

If there is real risk appetite for stocks and money managers around the world are allocating money aggressively towards stocks, we want to see similar strength in bonds. The fact that the riskier high yield bonds are getting flow at a faster rate than the more conservative investment grade bonds, suggests there is plenty of appetite for risk out there in the market.

As long as this ratio is above the downtrend line from the February highs, we want to be long this spread and confirms what we’re seeing in U.S. Stocks. If we start to break back down below it, then we’ll have to reevaluate this bullish thesis and maintain a more neutral stance in this ratio. From a risk vs reward perspective, the path of least resistance is higher and favors the bulls here.

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This post originally appeared on Investopedia.com on September 7, 2016

Tags: $HYG $JNK $LQD