It’s an important question, especially for those of us who maintain exposure to bonds.
And for those of us who don’t, it’s always good to know what’s going on in the fixed income space, as it’s often very valuable information.
Frankly, as investors, it’s irresponsible and negligent to not know what’s going on in this asset class.
It’s the largest market in the world!
And right now we’re seeing evidence of a shift in leadership toward High Yield Bonds $HYG.
We know it’s in our best interest to pay attention to this development so let’s look at a couple charts that suggest bond investors are reaching further out on the risk curve for a higher yield.
First up is high yield bonds relative to their safer alternative, US Treasuries: Risk-seeking behavior among bond market participants has cooled since earlier this year when the HYG/IEI ratio stalled out below a key level of former support that's now acting as resistance.
That could be changing, as the ratio is coiling and retesting this key level around .6725 for the second time this summer.
If and when this level is broken, we want to be long high-yield bonds over US Treasuries.
A break above this level would also signal that risk appetite is re-entering the bond market.
This is the type of behavior we want to see as investors, regardless of one’s bond exposure, as it supports higher prices for risk assets.
Look at the HYG/IEI ratio with an overlay of the S&P 500 ETF $SPY: They look almost identical off the March ‘20 lows as the speculative fervor was strong after the Covid sell-off.
But, like most of the market, the HYG/IEI ratio began to chop sideways early last March, suggesting risk-seeking behavior had cooled. We saw similar behavior in risk assets and risk-on ratios all over the place during Q1 and Q2 of this year.
Now that the S&P 500 has decoupled from the ratio as it’s continued grinding to new all-time highs for almost two quarters, we’re asking ourselves the following question:
Is it time for high-yield bonds to outperform again and clear up this divergence by catching higher to SPY?
Or does the S&P 500 correct lower toward the HYG/IEI ratio?
It’s too soon to tell, but if and when the HYG/IEI ratio reclaims its June highs from earlier this year, it’s certainly not bearish, and we definitely don’t want to get caught holding treasuries in such an environment.
