From the Desk of Ian Culley @Ianculley
Bonds are an absolute dumpster fire.
Everyone knows fixed income is having one of its worst years on record. And, from the looks of it, we’ll all be dragging our Christmas trees to the curb before US Treasuries stage a miraculous comeback.
Don’t get me wrong. I believe these safe haven assets will dig in and catch higher – eventually. There’s just no sign of it happening any time soon.
Instead of focusing on the disappointing performance of bonds, let’s turn our attention to its relative trends against other major asset classes – stocks and commodities.
Here’s the commodities versus bonds ratio using the CRB Commodity Index and the 30-year Treasury bond futures:
The commodity/bond ratio completed a bearish to bullish trend reversal last year after violating a decade-long downtrend.
This major intermarket shift caught many off-guard, as 12 years of underperformance led the industry to forget that commodities were even a viable investment alternative.
Fast-forward to today, and commodities are still unloved.
But it’s not due to their recent performance, as the entire group has been trending higher since 2020, sending the ratio back to test its 2014 highs.
This is a logical level for consolidation, meaning commodities could lose some ground relative to bonds in the short term.
However, the primary trend is still very much in favor of commodities.
It’s not surprising to see commodities outperform bonds, given the rising rate environment. When rates climb, commodities benefit, and bond prices fall – it’s a classic intermarket relationship.
However, to see stocks outperform bonds this year hammers home the punishment associated with owning US Treasuries.
It also underscores that investors have had nowhere to hide from the broad selling pressure.
The S&P 500 $SPY versus US Treasuries $TLT ratio broke to fresh highs last month as stocks embarked on another bear market rally. However, the near-term strength from the major indexes has begun to fade.
We'll see whether this leads to inflows into the bond market. So far in 2022, that hasn't been the case. Despite dropping more than 21% year to date, the S&P 500 has been a better place for your money than Treasuries.
But not all bonds are created equal…
Check out the dual-pane chart of the TLT/SPY ratio and the High-Yield Bond ETF $HYG versus SPY:
These ratios paint two opposing pictures. TLT/SPY has trended lower for the past couple of years, while HYG/SPY has been grinding sideways for the past 12 months, carving out a reversal pattern relative to stocks.
That’s because high-yield bonds are more akin to risk assets such as stocks than they are to other credit instruments.
Interestingly, the riskiest bonds on the street are a better place to be than Treasuries. When it comes to stocks, since this time last year, high-yield debt has performed more or less in line with the S&P 500.
There you go…
The safety play in the bond market this year has been high-yield corporate debt. As if we need any more evidence of how wild 2022 has been.
We outlined a trade setup in HYG last week, highlighting its near-term strength. If you have to own bonds with a maturity longer than a few months – the riskier, the better!
This post isn’t about buying high-yield bonds. That was last week.
The key takeaway today is US Treasuries have been terrible. But relative trends suggest a period of correction versus stocks and commodities.
A relative bid would go a long way for an asset class experiencing one of its worst years in history.
Once US Treasuries start to outperform their alternatives, we’re most likely witnessing the early stages of a significant bottom in the bond market.
Stay tuned!
Countdown to FOMC
Following Wednesday's 75-basis-point increase, the market is pricing in a double-hike in November, followed by a double-hike in February.
Here are the target rate probabilities based on fed funds futures:
Click the table to enlarge the view.
This data is from the CME FedWatch Tool as of November 3, 2022.
Thanks for reading. And please let us know what you think. As always, be sure to download this week’s Bond Report!
