Sponsored by

Market Looking Vulnerable: A Deep Dive Into Bond Spreads and Market Internals

Wed, Mar 27, 2019 - 11:20am

Corporate bond spreads have been in sync with the market up until January 2018. Since then they have been diverging and warned of the Q4 correction.

corporate bond spreads
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Of note is the divergence this month, signaling the market has likely gone further than it should. Bond spreads are more closely aligned with the weakness displayed in small caps, which have less buying support as stock buybacks play a larger role in the larger cap indices.

Consider This Stock Market Rally Has Everything, Except Investors

Companies keep buying huge quantities of their own shares, propelling prices higher even as pensions, mutual funds and individuals sit on their hands...

This year alone, Goldman Sachs analysts estimated, corporations will be by far the largest buyer of shares, with net purchases of $700 billion. Traditional investors like mutual funds, pensions, endowments and individuals are expected to be net sellers, parting with roughly $400 billion in shares.

corporate BAA bond spreads
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

One of the areas of concern cited by the Fed last year was the leveraged loan market, which took a nose dive in Q4. This space had a strong Q1 rally but has since peaked and is rolling over again.

leveraged loans
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.
leveraged loans daily
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results.
Subscribe to our Podcast! Click here for a 30-day free trial

Looking at corporate credit default swaps (CDS) there is a noticeable change in trend over the last few weeks that could be hinting at a corrective period ahead.

corporate cds
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results.

Of note is that 1-month and 3-month new lows on the Russell 3000 this past week have exceeded the levels from the early March decline while new highs have been moderating, signaling a thinning market that is eroding under the surface.

russell 3000 breadth
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Looking at the internals of the Russell 3000, the expansion in new lows on a 1-month and 3-month basis looks to be highest among health care, industrials, and tech, which carry some of the largest weights within US indices while new highs are in defensive sectors like REITS and Utilities.

russell 3000 sectors
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

While many technicians are citing new highs in advance-decline lines, cumulative new highs-lows tells a different story. The ADL for the Russell 3000 retested the highs seen last year while cumulative new 200-day new highs-lows has barely budged off the nadir seen in December of last year.

russell 3000 internals
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Despite the market’s strong run this year, more than half of the S&P 500 members remain 10% or more off their 52-week highs and nearly a third of the market remains in a bear market, similar to the dynamic we saw with the Q4 2015 rally off the summer lows prior to the large Jan-Feb 2016 decline.

52 week highs
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

If we look at a more broad-based index like the S&P 1500 (small, medium, and large cap) we see that the percent in bear markets is increasing yet again and never materially fell. The lowest the percent in bear markets fell to during the rally (~ 40%) was roughly the peak seen in the initial 2015 decline, not exactly encouraging and we are back to nearly 50% of the market is in a bear market.

sp1500 52 week high
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Looking at the internal momentum of the market, the percent of S&P 1500 members with monthly MACD buy signals had an incredibly weak recovery, similar to what we saw with the Q4 rally in 2015 and unlike the dramatic recovery seen in H1 2016, suggesting the corrective period that began in Q4 2018 is not yet over.

sp1500 macd buy
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

If we do move into a corrective period, the large cap space has a lot of room to fall.

sp500 room fall
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Mid caps look to be half way there towards an oversold condition.

sp400 midcap
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

While small caps are even further along in their corrective period.

russell 2000 breadth
Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Bottom line: The message from the internals of the market suggest caution over the coming weeks/months.

To find out more about Financial Sense® Wealth Management or for a complimentary risk assessment of your portfolio, click here to contact us.

Advisory services offered through Financial Sense® Advisors, Inc., a registered investment adviser. Securities offered through Financial Sense® Securities, Inc., Member FINRA/SIPC. DBA Financial Sense® Wealth Management.

About the Author

Chief Investment Officer
chris [dot] puplava [at] financialsense [dot] com ()
randomness