One of the things that we like to look at to get a gauge of the risk appetite out there is a ratio between High-Yield (Junk) Bonds and US Treasury Bonds. If money wants to go to work into risk assets like the US Stock Market, it makes sense that we would see similar action in the bond market. If money is flowing faster into risky Junk rather than the safer Treasuries, then we know that the behavior of the bond market is confirming the new highs in the stock market.
As you can see in this chart, whenever the S&P500 made new highs last year, the Junk/Treasury spread was also putting in new highs. This intermarket analysis helped us confirm what we were seeing in stocks. But so far this year, we’re not seeing that confirmation at all. In fact, all we see are lower highs while S&Ps hang out near fresh highs:
I’ve been pretty consistent all year about staying away from being long the US Stock Market Averages. I prefer other assets and would rather err on the short side in the stock market.
I look at this chart as another bearish divergence in Stocks and more of a reason to stay away or be outright short. There will always be individual equities that do well regardless of the environment. But the majority of stocks trade with the averages, so it makes it hard to find the few that do well. I’m the kind of guy that likes the wind behind his back. And unfortunately I don’t think that’s the case in stocks right now.
So what’s next? I would look for a break to new lows in the HYG/TLT spread to confirm a new downtrend as we would then officially have a series of lower highs and lower lows. I think a breakout above those February highs would be a positive for risk assets and would call into question whether or not this actually is a bearish divergence. I think that’s the lower probability outcome here and lower lows are likely in store for this bond spread. That’s not good for stocks.
Tags: $TLT $HYG $JNK $SPY $ZN_F $ZB_F $TYX $TNX