Relative Strength Analysis – Page 2

Risk On or Risk Off? [Weight of Evidence, Part…

November 17, 2014April 13, 2022

The credit (aka bond) markets overshadow the equity markets in terms of dollar value. Yes, the equity markets get all the publicity and headlines. However, it is the waters of the credit market that run deep. By looking at the current state of the credit markets, we can learn about the relative health of a large portion of the financial industry. When the bond markets speak, we listen.

At 360 Investment Research, we examine investor demand for various grades of credit (Junk Bonds, High Yield Bonds, and Treasuries). Specifically, we compare these grades against each other as a ratio. See the first chart below. This is a ratio of High Yield Bonds versus Treasuries, represented here by ETFs HYG (High Yield) and TLT (Treasuries) in blue. This ratio tells us the credit market’s appetite for risk. When in a speculative mood, funds will flow out of Treasuries (less risk for lower yield) and into High Yield Bonds (more risk for higher yield). When more risk is being taken, the ratio rises. The opposite also applies. When the bond market is seeking safety, it flies to Treasuries and the ratio decreases. This is what we find right now – the ratio has been declining – the credit market has been seeking safety since January. All the while, stocks (the more speculative market) have been rising. The credit market is seeking safety while the stock market seeks more risk. This is unusual behavior. Normally, they are in agreement. When big money managers are increasing positions of risk within the stock market, the same takes place in the bond market with funds flowing into High Yield credit. So the fact that we have this divergence is a problem. Who’s right? I don’t know, but it will resolve itself one way or another. Either stocks are going to correct downward or the credit market is going to flow into High Yield.

Even though we don’t know what will happen this time around, when we look at the past, the credit market seems to be right more often than not. That leads us to our second chart, which shows proprietary moving averages of the same type of ratio comparing High Yield Bonds v. Treasuries (JNK:TLT). This is placed in the same chart as the S&P 500. Not only do we notice that when the moving averages cross (green below orange), it’s a good time to sell stocks. We also notice that these ratio moving averages can give early warning signs through divergence. More often than not, the credit market flees to Treasuries before equities sell off. In 2011, the bond market diverged from stocks for more than six months before there was some type of resolution (stocks sold off). We find ourselves in the same spot now. The bond and stock markets have diverged from each other for the past 11 months. Who’s right? We don’t know, but we’re going to find out sooner or later. Either stocks sell off or the bond market seeks High Yield. Get your popcorn ready.

Don’t forget to share the wealth with your friends using the social media icons below. Check back soon for part 5 of our 7 part series.

It’s Just US Against the World [Weight of Evidence,…

November 16, 2014April 13, 2022

At 360 Investment Research, we believe price is the manifestation of opinion and final arbiter of value. That is, price has the final say. It doesn’t matter if we think price should be lower or higher from a fundamental perspective. No matter the security (stocks, bonds, currencies, commodities, whatever), price determines value. Opinions don’t matter. Price matters. Period.

One of the exercises we go through is to look at equity indexes across the globe to see if we can find opportunities or confirm price action happening in the largest equities market in the world – the United States. If stocks in the US are making new highs, we like to see stocks making new highs elsewhere in the world. If the US market is doing well and so are some other countries, that bodes well for the global economy. However, if we see the rest of the world lagging behind, we find that to be a warning sign. We are currently in this situation now. When we look across the globe, all major indexes (except for Nikkei, S&P 500, and the DOW) are making new lows or lower highs. Not higher highs. Take a look at the chart summary below (click it to embiggen), which condenses charts of the most important stock indexes in the world (some are ETF proxies). It is quite telling. The Dow Jones, S&P 500, and the Nikkei (Japan) are the only indexes making new highs. We’d like to see more countries join the party by making new highs along with the US. Needless to say, we will be paying close attention to prices across the globe with a keen eye on the United States. You should be watching price action closely too.

Check back soon for part 4 in our 7 part series.

11-16-2014 World Tour [weight of evidence, 3 of 7]

Category: Relative Strength Analysis

Risk On or Risk Off? [Weight of Evidence, Part…

It’s Just US Against the World [Weight of Evidence,…