Will We See A Shift Out of High Yield Bonds and Back to Treasury’s?

Since the election last week the markets has been digesting the new set of expectations with regards to where growth is expected to increase (small caps, biotech seeing large pops) or decrease (large cap tech). The same type of movement is also taking place in the bond market with Treasury’s seeing a fair bit of weakness as rates rise. The 10-year Treasury yield is now at its highest level for the year with many bond ETFs seeing their lowest levels. On a relative basis, high yield debt has not been hit as hard as government debt, which is the focus of this post.

Below is a ratio chart comparing the iShares High Yield Corporate Bond ETF ($HYG) vs. the iShares 20+ Year Treasury Bond ETF ($TLT). As a reminder, when looking at a ratio chart like this, if the line is rising then the numerator, int his case, $HYG, is rising more or falling less than the denominator (i.e. $TLT). This is a great way to be able to analyze two markets and see which one has stronger relative strength. The second half of 2016 has seen a shift to favoring high yield debt over Treasury’s. This increase in relative performance has sent the Relative Strength Index (RSI), a momentum indicator, to a historically high level. In fact, we’ve only see four previous instances where the RSI has been this high for the HYG/TLT pair since 2007.

As shown by the dotted blue lines, when RSI has gotten this high in the past we’ve typically seen a reversal in relative strength. Three of the four prior occurrences (2007, 2010, 2015) were substantial shifts in trend while the instance in 2012 didn’t have a complete about-face in relative performance, we did see TLT pick up a little in relative performance for several weeks before bottoming out and $HYG continuing to lead for the bulk of 2013.

So while the sample size is extremely small, it does appear the trend for high yield debt  leading Treasury’s has come to an impasse. Momentum has become stretched and this elevated reading in the RSI can be resolved in two ways…. through time, which means we could see a consolidation in the $HYG/$TLT ratio or a reversal in trend. However, as we saw in 2013, the magnitude of the trend reversal may not last very long or produce dramatic changes in the overall trend. 

hyg-tlt

 

The Relationship Between Stocks and Bonds Remains in a Range

Miss me? I haven’t been as active on the blog as I would like but I still share quite a bit on Twitter and StockTwits, so make sure follow me there to keep up with my insights and charts. Anyway, let’s get into it…

We are close to finishing out the historically bearish period of seasonality for equities and while we didn’t see any kind of crash that many traders were hoping for expecting, the S&P is up nearly 4% and saw just a 5% drop back in June. Overall, not a terrible summer when all things considered.

The chart I’d like to discuss today is of the weekly un-adjusted (not accounting for dividends) ratio between the S&P 500 ($SPY) and 20+ Year Treasury Bond ETF ($TLT) over the last seven years. As a reminder, when $SPY is outperforming $TLT the line rises and when the opposite happens the line declines, this doesn’t mean equities are appreciating, it simply shows which data set is rising more (or falling less) than the other.

I think it’s important to monitor the relationship between stocks and bonds and that’s exactly what this chart helps us do. The ratio between these two markets has been in somewhat of a range since late-2013 as it has been unable to produce a meaningful new high or lower lows. This creates a consolidation triangle pattern that we can view as levels of support and resistance with regards to the relative performance of $SPY and $TLT.

As the chart below shows, the ratio has found prior support at 1.45, which if broken could see a decline down to 1.35 which is the last significant area of price memory (2010 turning point and 2013 slight decline). On the upside we have a declining trend line connecting the lower highs since 2015. A break here could see $SPY outpace $TLT with the ratio rising back to its prior high around 1.80. To better gauge a break of either resistance or support (one will eventually have to happen whether it’s due to pacing of time or price movement) I’ll evaluate trend strength (not shown on chart) to better understand the potential the break has ‘staying power’ and the potential of a false break or reversal. But at this point, we have our levels and can be patient, allowing the market to dictate a bias.

stocks-vs-bonds

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Stock Market Hits New Highs But Lacks Confirmation

While the S&P 500 breaks through 1900 and traders rejoice over the fresh new high, it seems the same level of excitement is not being felt in other parts of the market. There are multiple divergences that are taking place and showing a lack of confirmation. On my blog I’ve discussed multiple times the lack of participation in momentum for the S&P 500, but we can also see divergences in bonds, small caps, and defensive sectors showing leadership. However, the two measures we are seeing excessive risk taking in are the Put/Call Ratios and the Volatility Index which is sitting at historical lows. The other measures I follow appear to be negatively diverging from the overall equity market. Below are some examples.

Below is a chart I referenced earlier this year; it shows relative performance of High Yield Corporate Bonds ($HYG) vs.U.S. 20+ Year Treasury’s ($TLT). In the bottom panel we have the 10-Year Treasury Yield ($TNX). For the bulk of the current bull market we’ve seen these two measurements for the bond market confirm the movements in equity prices. As stocks go up, so does the ratio between HYG and TLT as investors show preference for the more risky high yield market over government debt, and same for the 10-Year Yield which often moves with the stock market. However, that’s now the case today. We have a glaring divergence forming in both measures of risk within the bond market, something we haven’t seen since the 2011 and 2012 highs.

bond divergence

Next we have a chart showing the S&P 500 ($SPX), PowerShares Nasdaq ($QQQ), and the Russell 2000 iShares($IWM). While the S&P hits new highs the Nasdaq and Russell 2000 are off nearly 5% from their 52-week highs. SentimenTrader.com wrote in a recent note that some examples of past instances of this occurring are: 1983, 1987, 1990, 1998, 2000, and 2006. Jason wrote that the eventual ‘reaction’ of this divergence in the S&P 500 varies in length, “from immediately (’83, ‘90’, ’00) to over a year (’06). If traders were feeling more confident in the upswing in stocks, why aren’t they bidding up these higher beta indices?

To keep reading and see the rest of the charts: Stock Market Hits New Highs, But Lack of Confirmation Concerning (See It Market)

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.