Bond Investors Embrace Risk

From the Desk of Ian Culley

It’s impossible to ignore – investors are reaching for risk.

Biotech stocks are catching higher. Copper futures are working on their tenth up-day in a row. Even the Emerging Market HY Bond ETF $EMHY is breaking to 7-month highs as it completes a multi-month base. 

And don’t forget about Silver! Gold’s crazy cousin has proven by far the best-performing asset since the US dollar peaked last fall. Strength among these market areas indicates a healthy risk appetite.

I can’t overlook these signs of a constructive bottoming process, especially considering the next chart…

Check out the Emerging Market Bond ETF $EMB relative to the US Treasuries ETF $IEF:

There’s plenty to unpack here…

First, the EMB/IEF ratio is challenging fresh 7-month highs after posting a higher high and a higher low last fall. A bearish to bullish trend reversal is underway for this important risk-on ratio.

You can add this to the growing list of bullish data points suggesting the market is carving out a tradeable low.

Second, a bearish divergence in the EMB/IEF ratio led the SPY into its 2022 peak by several months, warning of weakness to come for risk assets. 

Last summer, the ratio printed another divergence. But this time, it represented a bullish signal as the risk-on ratio carved out a higher high while the SPY fell to new lows.

Does last fall’s bullish divergence mean the S&P 500 will follow the EMB/IEF ratio higher?

I don’t know. But I don’t want to make the bet these longer-term trends resolve in opposite directions.

Lastly, EM bonds peaked relative to US treasuries in early 2021, around the same time the new 52-week highs peaked for the broad market Russell 3000 index $IWV. That’s an interesting coincidence!

On the flip side, the EMB/IEF ratio bottomed in early July of last year, just weeks after the new 52-week lows peaked for stocks in late June. How about that!

It’s not rocket science, it’s the bond market – the largest market in the world. If bond investors dial back their risk exposure, it’s for good reason. The same is true as they welcome additional risks.

If the EMB/IEF ratio continues to rise, I believe the major global indexes will eventually do the same. But the SPY remains messy for now. Instead of trading the index, I’d rather focus on finding individual names to buy. It’s that simple.

Bond investors are embracing risk again. Highly speculative assets are catching a bid, from silver futures and biotech stocks to emerging market debt and crypto.

You can either choose to disregard the obvious or listen to the largest market in the world – the bond market.

Did I miss anything… Am I overthinking it?

Are you buying stocks or pressing shorts here?

Let us know. We love hearing from you.

Countdown to FOMC

Following the recent double-hike, the market is pricing in a single-hike at the February meeting.

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 January 19, 2023.

Thanks for reading.

As always, be sure to download this week’s Bond Report!