From the desk of Steve Strazza @Sstrazza
We are always looking at intermarket signals and ratio charts for insight into various asset classes. We’ve recently written plenty about intermarket relationships that signal risk-appetite, or lack thereof, for stocks as well as others to get a read on yields.
Today’s Chart of the Day, High Yield Bonds (HYG) vs Short-Term Treasuries (IEI), is one of our favorite risk-appetite ratios.
Credit Market investors favor High Yield Bonds over Treasury Bonds during the “good times” – periods of strong economic growth, rising rates, etc. On the other hand, we know treasuries are a safe-have asset and outperform in environments where investors are uncertain and want a place to park their capital until the smoke clears.
This rush to safety is exactly what we’ve seen occur since the majority of stocks peaked in January.
In fact, when the major US Stock Market averages made incremental highs in February, this ratio was one of many bearish divergences we were looking at, as prices failed to make a new high before rolling over along with equities.
Here is the chart, showing prices retesting former support at 2016’s low after recently plunging to a fresh all-time low.
Click on chart to enlarge view.
The last time this ratio was at such low levels was in March of 2009, the same time equities bottomed following the Financial Crisis. But before you read too much into that, notice the price action preceding that low.
Prices collapsed as momentum registered its most oversold reading ever in October of 2008, and amid some extreme choppiness, two more incremental lows were made over the subsequent five months. The ratio eventually formed a bullish momentum divergence and bottomed, but it took time. Remember, bottoming from a fall like this is a process, not an event.
That brings us to today. This ratio just fell off a cliff and registered its most oversold reading since the one from 2008, and then whipsawed higher. The setup is strikingly similar and we wouldn’t expect this time to be any different from the last.
As such, price is likely to fail at its current level and take months to carve out a bottom. You can expect plenty of volatility in this ratio in the meantime.
High Yield Bonds (HYG) fell over 22% during the recent selloff and are still roughly 9% below their Q1 highs. Meanwhile, the Short-Term Treasury ETF (IEI) is about 5% higher since stocks peaked and went out today at fresh all-time closing highs.
We actually like treasuries a lot, not just on a relative basis but also on an absolute basis. Here is a chart of the US 5-Year Note which is a good proxy for IEI as the ETF holds treasuries with 3-7 years to maturity with a roughly 5-year average effective maturity.
If prices are above their 2013 and recent highs just above 125, we want to be long the US 5-Year Treasury Note with a 3 to 6-month price target at 133.
You can also express this bullish thesis on treasuries via the ETF itself. We like IEI if it makes a sustained move above recent highs around 133.50 with a 3 to 6-month price target at 143.
The bottom line is that many of the intermarket relationships we use to gauge risk appetite among market participants are at key inflection points, similar to High Yield vs Treasury Bonds. Additionally, safe-haven assets like gold (GLD) and treasuries are making new highs.
None of this is characteristic of a risk-on environment for equities. If bears are going to retake control, now would be a very logical level and time for that to happen.
We want to be fading this ratio as long as prices remain below former support and buying Short-Term Treasury Bonds on an absolute basis on a move above recent highs.