The market’s recent rally is more than just short-covering with buyers attempting to step back in after the August crash, but there’s still damage under the surface when considering market internals and the underlying health of the credit markets, said Patrick Nipper, Senior Technical Analyst at Renaissance Macro, in a recent interview with Financial Sense Newshour.
Pat cites RenMac’s proprietary trend model, which turned bearish in August and is now back to neutral. However, “because the model hasn't improved enough we don't think that we're back into a long-term bull trend,” he said. “We think enough damage has been done to the market that there's some things to worry about.”
One of the key areas they are watching to determine whether major market indices like the S&P 500 (SPY) may correct further or stabilize and head higher is the credit market.
What is the credit market?
For those that are unfamiliar with this term, Investopedia defines it as the following:
The broad market for companies looking to raise funds through debt issuance. The credit market encompasses both investment-grade bonds and junk bonds, as well as short-term commercial paper.
And, to further underscore the importance of watching the credit market for any spillover effects into the stock market:
The credit markets dwarf the equity markets in terms of dollar value. As such, the current state of the credit markets tells us the relative health of a large portion of the financial community if we examine the prevailing interest rates and look at investor demand for various grades of credit - from "riskless" (as in Treasury Bonds) to junk bonds that carry high default risks. More demand from investors will prompt companies and lenders to issue more bonds, the effects of which will spill over into the equity markets.
As such, Pat says the credit market picture “kept getting worse and worse and worse” starting around six months ago “until finally the equity market followed suit.”
When asked about the current market rally and where things stand more recently, RenMac’s Senior Technical Analyst said “we have seen some modest improvements, but we have not seen them come roaring back and those are the kinds of things we are going to look at to determine whether we have more problems ahead for the market in terms of another leg lower or if we can signal the all-clear yet.”
Here are a few excerpts from his recent podcast interview (preview below). Subscribers can access the full audio by logging in and clicking here.
Patrick, what’s your current reading of the stock market given the double-digit decline we saw late August?
When the market first cracked in August it actually turned our trend model negative, which is a pretty useful indicator to give us a baseline of where we think the market is heading from a strategic sense. That model has improved a bit with the current rally back to something of a neutral reading but it has not turned bullish for us yet. And because the model hasn't improved enough we don't think that we're back into a long-term bull trend. We think enough damage has been done to the market that there's some things to worry about. We could see another leg lower. Now, having said that, the rally off of the low has been meaningful and we've seen a lot of good internals on it: we've seen great breadth; we've seen great volume; we've seen all the types of accumulation that you would want to see for a sustainable rally so we don't actually think it's petering out yet.
So, you could see the market head lower but you think that the current rally is sustainable for the time being?
I know that those two concepts sound to be a little bit contradictory but it's really a matter of timing. This rally has been strong enough—it's more than just short-covering—it is people who are buying into it. We think it has more legs, perhaps into November, but because we have seen cracks in the trend we don't think that we've seen the all-clear. We wouldn't say, 'OK, you know what, this is a great rally. We're back into it. Let's start powering to new highs.'
What sorts of things are you watching or have on your radar to help determine whether this is the beginning of stages of a bear market or just a correction in a bull market?
We will look at things like credit. Credit is very important to us. We'll want to see if the credit market is confirming what the equity market is saying. And some of the areas that we look at in the credit market are places where you can really get a good handle on the risk-on/risk-off mentality. For instance we'll look at credit default swaps. We'll also look at spreads between BBB bonds and Treasuries—that gives us a pretty good indication of where the mentality is and those have generally been looking poor for the better part of 6 months.
This crack in the market that happened in August was a long time in coming. Credit was deteriorating and it was a little bit vexing as the market continued to go higher...but the credit picture kept getting worse and worse and worse until finally the equity market followed suit. Now in the current rally, we have seen some modest improvements in these credit spreads, but we have not seen them come roaring back and those are the kinds of things we are going to look at to determine whether we have more problems ahead for the market in terms of another leg lower or if we can signal the all-clear yet.
Where do you see current credit conditions compared to prior market tops? Are we seeing wider deterioration across sectors outside of energy?
In terms of our overall credit picture...we're not seeing [deterioration] that is as bad as the bear markets we've seen over the past decade so that's good. In terms of individual sectors, although energy is the worst looking of the areas, we're also seeing weak credit conditions in other sectors as well—really, across the board. Even the sectors that are doing well. Credit is not giving those warm fuzzy feelings where spreads are coming in and default swaps are getting cheaper to insure to where we'd be saying, 'OK, there's some underlying health here.'
Listen to this full interview with Renaissance Macro’s Senior Technical Analyst, Patrick Nipper, by logging in and clicking here. For a complete archive of our broadcasts and podcast interviews on finance, economics, and the market, visit our Newshour page here or iTunes page here. Subscribe to our weekly premium podcast by clicking here.