We do a lot of intermarket analysis on a day to day basis either for confirmation or to look for divergences. One of my favorite ways to gauge investor risk appetite is to follow a ratio between Junk Bonds and Treasury Bonds. If there is a real demand to put risk on the table, I want to see flow into Junk outpace that into Treasuries. If managers are worried, you would expect money to be allocated towards risk-free government debt at a faster rate than Junk Bonds.
Today we are taking a look at the Junk to Treasury bond ratio ($HYG vs $TLT) hitting a new 52-week low this week while the Dow Jones Industrial Average hits new all-time highs. We want to see the bond market confirming the action in stocks, not diverging by this much. The bond market is giving us a much different message:
There is an old saying on The Street that the bond market is smarter than the stock market. I don’t know if that’s true or not. I like to think so. But what’s more important here in my opinion is that one is not confirming the other. The flow into risk-free government debt is really outpacing the flow into the riskier Junk Bond market. That’s not a good sign of risk appetite, at least not to me.
The trend in this ratio is still lower. We’re hitting fresh 52-week lows this week as the headlines read, “Dow Jones Industrial Average Hits Another Record High”. Remember the market is not 30 stocks. There’s a lot more going on here. I’m sticking with a cautious stance in US equities as a group for a lot of reasons. There are some individual less correlated stocks out there that I would prefer to be in if we have to be in stocks. Pairs are also a valuable tool that allows us to maintain an equities neutral position.
This is a bearish time of the year. So this makes sense to us from a seasonal perspective as well. Feel free to read some of my recent posts about stocks:
FOX Business: Brazil Over Germany This Summer (July 12, 2014)
The Dog Days Of Summer Are Upon Us (July 8, 2014)
Radio: Winning On Wall Street (July 1, 2014)
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Tags: $DJIA $INDU $YM_F $HYG $TLT $JNK $ZB_F $TNX $TYX $IEF