From the desk of Ian Culley @IanCulley
No one likes a bear market, except for the bears of course.
They haze the uninitiated, test market veterans, and remind everyone that assets can go to zero.
Not fun for most!
When we take a step back and assess all the data in front of us today, the outlook remains dismal for the overall market.
The New York Stock Exchange and the Nasdaq have posted more new lows than new highs for 31 weeks and counting. Leadership groups carry a defensive tone. Topping patterns continue to resolve lower. Support levels are being ignored and violated. Long story short, it’s ugly out here.
And it’s not only stocks… Bitcoin just booked its worst month and quarter in over a decade and bonds are having one of their worst years in history.
No wonder investor sentiment is in the dumps. It’s clear we are in the midst of a bear market.
They’ve replaced the comical “stocks only go up” memes with images of the grim reaper coming for our favorite names. Even memes aren’t as funny in a bear market!
Given the current environment, we continue to rely on two key areas of the market for insight: junk bonds and credit spreads. They both offer excellent information, particularly when markets are in turmoil.
Let’s revisit these areas today.
Spoiler alert: We probably have a rough road ahead!
Here’s a chart of the High-Yield Bond ETF $HYG with a five-day rate of change in the lower pane:
Last month we noted a momentum thrust in HYG, highlighting the extreme reading and the significant bottoms that coincided with similar upside thrusts in the past.
This led us to expect bullish follow-through in the subsequent weeks. But it never materialized.
Instead, HYG turned lower and booked its worst 5-day performance since the summer of 2011. This downside thrust counteracts the bullish reading from May.
These are the types of wild price and momentum swings that accompany bear markets. It’s called volatility.
More importantly, the recent selloff in high yield has put upward pressure on credit spreads. We like to pay close attention to these riskier bonds as they have a tendency to drive spreads due to their high beta.
Here is an overlay chart of the S&P 500 $SPY and credit spreads measured by High-Yield Bonds ETF HYG relative to the US Treasury ETF $IEI:
Notice how credit spreads tightened as HYG bounced higher last month. Unfortunately for the bulls, that rally, like most bear market rallies, was short-lived.
Now that high-yield bonds are pressing toward fresh lows, they are driving the HYG/IEI ratio lower with them. That means credit spreads are widening and debt markets are signaling increasing stress.
And, as the above chart implies, that’s not good news for stocks.
Let’s be honest: There hasn’t been a lot of good news for the stock market lately.
Volatility is running high across all the major asset classes, including currencies and crypto. Bears are keeping rallies short and sweet. And earnings calls are peppered with “revenue quality” notions as executives steer the conversation away from slowing growth.
We can tack high-yield bonds and credit spreads onto this growing list of bearish developments.
As long as these critical spreads continue to widen, things are probably getting worse for risk assets. And if that’s the case, the only ones having fun are the bears.
Countdown to FOMC
The market is pricing in a 75-basis-point hike at the July meeting next month.
Here are the target rate probabilities based on fed funds futures:
Click the table to enlarge the view.
Thanks for reading.
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