Defensive areas we would expect to underperform in the current environment such as utilities and REITs are actually outperforming.
And the names we would expect to do well – specifically banks – can’t seem to catch a bid on either absolute or relative terms.
This is concerning from a broader intermarket perspective. But it’s not the complete story.
While our stock market ratios are not supportive of higher rates, when we look within the bond market, we’re seeing the opposite.
Not only is there a synchronized global rally in interest rates, but the intermarket evidence from our bond market ratios supports this action and indicates a healthy degree of risk appetite.
Today we're going to highlight one of those bond market ratios – high-yield vs. investment-grade debt.
Let’s take a look.
Here’s an overlay chart of the US 10-year yield and the junk versus investment-grade bond ratio, $HYG/$VCIT:
As rates rise, higher-yielding instruments tend to outperform their safer alternatives such as investment-grade bonds. And that’s exactly what’s happening.
This is illustrated by the HYG/VCIT ratio breaking to fresh multi-year highs along with the US 10-year yield.
The outperformance from high-yield bonds not only supports the move in rates but also speaks to an increasing appetite for risk.
Basically, when times are good, investors are more willing to take on higher risk, even if the excess yield they are getting for it is shrinking… like it is today.
To see high-yield debt catch a relative bid tells us that bond market participants are confident enough about the present environment to take on the additional risk that accompanies these bonds. And that's definitely not bearish.
While this is a positive development, this kind of risk-seeking behavior is more or less absent in equity markets. The same is true when we look at other key intermarket ratios, such as copper versus gold.
We’re just not getting the same confirmation as we are from the bond market.
So, the question we’re asking ourselves right now is simple…
Who has the right read on interest rates?
Is it the bond market, which is telling us the recent rally in rates is likely a sustainable one?
Or is it the stock market, which is telling us not to trust these new highs?
We'll keep you updated as more information presents itself. Stay tuned!
Countdown to FOMC
Following the Federal Reserve's recent rate hike, the market is pricing in a 50-basis-point hike at the May meeting.
Here are the target rate probabilities based on fed funds futures:
