From the desk of Steven Strazza @Sstrazza and Grant Hawkridge @granthawkridge
In today's post, we’ll discuss some of our favorite and most important intermarket ratios and see what they’re suggesting for markets and risk appetite around the globe.
One thing we found interesting when digging through these charts is that many of them look a lot like stocks do right now.
Sideways. Range-bound. Messy. But, within the context of underlying uptrends.
So these are basically just continuation patterns on shorter timeframes.
But, after consolidating for months and even quarters now, we are beginning to see some resolve higher… kind of like we’re seeing from stocks on an absolute basis.
Coincidence? Probably not.
We think this makes a lot of sense and bodes well for risk assets. Let’s take a look at some of these charts now.
Here’s one of the most important cross-asset ratios we track, and it’s a great example of exactly what we’re talking about.
This is the stocks-versus-bonds ratio $SPY/$TLT:
Notice how this ratio has been consolidating in a sideways range and digesting its gains from last year for the past several months?
Sounds a lot like the stock market to me. In fact, SPY/TLT transitioned into a sideways mess right around the same time stocks and most other risk assets did the same thing earlier this year.
So maybe an upside resolution would support another leg higher in stocks? Just a thought...
But what does this ratio really tell us?
Simple: It tells us where we should focus our attention and allocate our capital. It shows us where the alpha is, whether it be the stock market or the bond market.
Up until earlier this year, it had been all stocks, as they consistently outperformed their more defensive peers in the bond market. And then the ratio paused at our objective and has been hanging out there in a tight continuation pattern ever since.
Seeing how things have been developing in other areas, combined with the fact that buyers are once again testing the upper bounds of the recent range in SPY/TLT, we think the writing is on the wall for stocks to take the wheel and drive this ratio higher.
This next ratio is one of our favorite ways to measure risk appetite for stocks. This is the Consumer Discretionary Sector SPDR $XLY relative to Consumer Staples $XLP:
Price is currently sitting right below a significant resistance level.
The implications of this ratio breaking out above these former highs are simple. It would be bullish for risk assets and suggest a more offensive tone among investors.
Now let’s illustrate this same relationship but using the equal-weight sector ETFs:
Similar to their cap-weighted peers, $RCD/$RHS has also been a sideways mess for several months.
However, last week it resolved higher from its continuation pattern.
As long as we hold above those April highs, this action suggests we could be entering an environment more conducive to risk-taking than the one we’ve been in since Q1.
Here's another chart that supports an increasingly risk-on tone:
Staples $XLP and Utilities $XLU continue to collapse relative to the broader market. Seeing this type of underperformance and new lows from these bond-proxy sectors is supportive of an environment where the broader stock market is trending higher on an absolute basis.
This is evidence of risk appetite, not risk aversion.
Just to be clear, these groups are breaking to new absolute highs even as they make new relative lows.
Both of these are characteristics of a strong stock market supported by healthy risk appetite.
Next we have the Copper/Gold ratio, which is one of the most valuable intermarket data points we use:
This ratio recently reversed at a key level of resistance at its 2018 highs, when risk appetite peaked around the globe during the last cycle.
What we should all be asking is whether this was a failed breakout or merely a false start.
Since we didn’t see much of a reaction to the downside following these failed highs, we’re leaning in the direction of a false start. That’s even more true when we consider the weight of the evidence and what we’re seeing from some of our other interest rate barometers.
We think this ratio is ready for another attempt to break out above this key area of overhead supply.
And guess what: Rates are probably breaking back above their risk levels in an environment where Copper/Gold is back above its 2018 highs.
But not all of these intermarket ratios are resolving to fresh highs or lows and breaking out. There are also plenty that are simply catching support and rebounding off logical levels but remain stuck in trading ranges.
Again, this sounds a lot like what many stocks have been doing, particularly the weaker names and groups. Let’s look at some of these ratios now.
Here’s High Beta $SPHB relative to Low Volatility $SPLV:
As you can see, the riskier, higher volatility names have cooled off and have been underperforming the low volatility names for several months now. The entire run-up off last year’s lows was a beta chase, whereby we saw these stocks outperform by a wide margin.
If we’re headed back to an environment where risk assets are trending higher, we’d imagine this ratio is trending higher as well. For now, it’s held support at a key level. We’ll have to wait and see where we go from here.
Next up is Home Construction $ITB relative to REITs $IYR:
This ratio looks quite similar to SPHB/SPLV, as it just dug in at its former lows and bounced higher off the lower bounds of its trading range. As long as price is stuck beneath those year-to-date highs, the bias is neutral at best.
Last but not least, we have our risk-on/risk-off index. Its price action in recent months is an excellent illustration of the indecision among market participants, as it’s done nothing but chop around sideways.
If our risk-on/risk-off ratio breaks out here, it’s probably happening in an environment where other risk assets and ratios such as Emerging Markets and Broker-Dealers versus the S&P are making new highs as well. In fact, we’d probably be experiencing continued strength across more cyclical areas, which would be a big positive for global risk. But without a clear move toward a more risk-on environment just yet, a less-is-more attitude and patience toward markets remains appropriate.
While things are certainly headed in the right direction, there's still work to do from an intermarket perspective.
Here’s our updated risk checklist, which does an excellent job of summarizing the current global landscape:
This table identifies key levels in the most influential markets and relative ratios and tells us whether these charts are above or below our key levels.
Currently, only 40% of our list is in risk-on territory. Despite the bullish action this week, the checklist has been basically unchanged.
That’s not likely to be the case for long. Notice how so many of these charts are sitting right near their key levels? This tells us that this list can swing in favor of either the bulls--or bears, with just a few days of strong price action in either direction.
All we can do for now is sit back and let these developments unfold, as the weight of the evidence remains split right down the middle.
But things are back in the bulls' court for now, so maybe they take back the reins and drive risk assets higher in the coming weeks.
Alternatively, maybe all this progress unravels and the bears regain control of markets.
Or maybe things just remain a sloppy mess for longer... now that would be the real "pain trade."
It’s simply too soon to make a call. All we can do is remain flexible and open to new information and keep a close eye on these key levels moving forward to gauge the market’s overall health.
We’ll be back with more updates next week!
Let us know what you think and as always, please reach out with any questions.
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