Published April 13, 2018
With our TimingCube Turbo model we are either on a Buy signal or a Sell signal, holding a long position (Buy) or a short position (Sell). While we are taking risk with any signal, (we could win or lose) most investors take a single view of the market, as either going up (winning) or going down (losing). The market is either “risk-on” or “risk-off”. It would seem easy to tell whether the market is happy or not by whether it is rising or falling. However, that simple approach doesn’t necessarily tell the story. To get a better feel for how markets are feeling we can look at relationships between riskier assets and safer assets. For example, we look at whether investors favor high-yield bonds (thus, willing to take risk) or prefer the safety of “risk-free” U.S. Treasury bonds. The line below shows the trend between high-yield bonds and U.S. Treasury bonds. When the line is rising, investors favor high-yield bonds. When it is falling, they want the safety of U.S. Treasuries. We see below three distinct periods of the line falling – of investors seeking safety: 1) On the far left of the chart during the financial crisis, 2) in the second half of 2011 as investors fretted over the possible demise of the Euro and concerns over whether the U.S. Congress would let the government shut down, 3) a longer period from mid-2014 to mid-2016 as oil prices plunged leading to fears of high-yield bond defaults. We see on the right side of the chart the present day LACK of concern among investors, despite a stock market that has become very volatile.
Below, zooming in closer we look at whether the monthly data is above or below the trendline. In other words, is the trendline in danger of starting to roll over and decline, which would suggest investors are shifting to a focus on safety? No! Investors continue to favor high-yield bonds over the safety of U.S. Treasury bonds. Note that this preference is occurring even though high-yield bonds are not offering very much more compensation, in the form of higher yields/interest (only about 2-3% more; half of the average).
Expanding this approach we can check whether investors prefer the risk of owning stocks to holding risk-free U.S. Treasury bonds. Again, if the ratio is trending up, investors want stocks and are OK with the risk. Trending down and investors are fleeing to safety. On the left side we see that about 2007 investors began preferring safety, presaging the coming plunge in stock prices. This preference shifted abruptly at the beginning of 2009 with investors moving into stocks. This preference has been unchanged since, albeit with periods of uncertainty in between. The blue dashed line shows a clear breakout in this indicator after the last presidential election, a move that reached a zenith a the beginning of this year.
We are now working off that excessive move and may be preparing to resume the uptrend of stocks over safe assets. OR, we might be moving into one of those 2-3 year periods where uncertainty prevails and investors take a more neutral view between safety and risk.
Market Update
After weeks of hair-raising volatility, stocks turned into the quarterly earnings season with a relatively relaxed week of trading. Monday saw the indexes adding +0.3% after some easing of trade war fears. That sentiment fueled a strong rally Tuesday. Indexes popped higher by +1.7% with energy shares zipping upward by over +3% as the U.S. and Russia traded barbs over possible military action in Syria. Facebook’s chief, Mark Zuckerberg, began testimony before Congress, which sent shares of his company, a large component of the Nasdaq 100 (QQQ), almost +5% higher. Stocks gave back -0.5% Wednesday as Syrian tensions continued. That dip was quickly recovered Thursday with bank shares pushing higher ahead of their earnings releases, scheduled for Friday. The stock market added +0.8% as the White House appeared to back off near-term Syrian action. Oil and energy shares continued their ascent. The banks delivered strong results Friday morning, but investors sold the news. U.S. Treasury yields saw the yield curve flatten further to a 0.45% difference between the yield on 2-year and 10-year bonds. Investors fear an “inverted” yield curve where short-term rates are higher than long-term rates as such a situation has generally preceeded a recession. The flattening of the yield curve is a step toward the inverted curve condition.
For the week stocks bounced off their major trendlines to post solid gains with the S&P 500 (SPY) rising +2.08%. The Nasdaq 100 (QQQ) lifted +3.03%, while the small-cap Russell 2000 (IWM) gained +2.39%.
Warm wishes and until next week.