Investment-Grade Debt vs. Treasuries and Stock Market ImplicatioIntroduction:
The ratio between investment-grade corporate debt (LQD) and 3-7 Year Treasuries (IEI) serves as a key measure of market liquidity, carrying important implications for the stock market. When this LQD-to-IEI ratio rises, it indicates stronger market liquidity, typically reducing the risk of a stock market downturn. Monitoring this ratio can provide early signals on the market’s broader risk environment.
Analysis:
Liquidity Signal: A rising LQD-to-IEI ratio reflects improved liquidity conditions, which can offer a more favorable environment for stocks by reducing systemic risk and easing funding conditions.
Technical Pattern: Currently, the LQD-to-IEI ratio is approaching a potential breakout from a rounding bottom formation, which is a bullish pattern. A confirmed breakout, possibly supported by recent Federal Reserve liquidity measures, would strengthen the case for a continued stock market uptrend.
Market Implications: A breakout in this ratio would indicate robust liquidity, offering a supportive backdrop for stock gains. Strong liquidity tends to encourage investment in equities, as it alleviates funding pressures and risk concerns.
Conclusion:
The LQD-to-IEI ratio offers a vital signal of market liquidity, with a potential breakout from its rounding bottom pattern indicating a bullish scenario for equities. If liquidity conditions remain strong, stocks could see continued support, reducing the chances of a market crash. Do you agree with this outlook on liquidity’s impact on stocks? Share your perspective below!
Charts: (Include relevant charts showing the LQD-to-IEI ratio, the rounding bottom formation, and breakout potential)
Tags: #Liquidity #CorporateDebt #Treasuries #StockMarket #LQD #IEI #TechnicalPatterns
LQD
IEF/LQD Ratio (Financial Conditions) Daily - EasingThis chart is an inverted chart of the IEF/LQD ratio with a SPX (SP500) overlay line chart Not Inverted . This shows the corrrelation to easing conditions and the S&P500. This is what the FOMC is failing at fighting. With QT and rate hikes, this has only had pullbacks. Jawboning too.
Short to long term analysis of the SPXIn my last post I outlined the potential of a near-term breakdown of price action as the SPX was moving in a Bearish pennant consolidation pattern, The SPX has now developed into a more classical bear flag continuation pattern. We can see that the downwards trendline is holding price action, and that the bearish pennant has turned into a more typical bear flag continuation pattern presenting itself with higher highs and lower lows.
I expect a breakdown of price action to present itself soon. More specifically closer to 3890 levels forming a double top with the price action of mid to late December followed by a breakdown below the bear flag trendline. The levels of around 3890 coincides fib retracement level 0.382 from the mid December top. Although price action could very well breakdown before said double top target is reached as well as below it.
A note on the indicators used, feel free to skip if you are already aware of their functionality and usage:
To explain the log-adjusted regression line, it shows price action plotted on a red linear regression line, which is also log-adjusted for use in particularly longer periods of price action. The blue line to upside and downside is respectively 2nd standard deviations above and below the linear regression. Price of a symbol can be considered more expensive on average, relative to all price-action from the point that the reg-line is plotted, if the price is above the reg-line whilst the opposite is true if the price is below the reg-line where the extremes of both cases are indicated by reaching the 2nd standard deviation of either side i.e. the blue lines.
Also to quickly explain the EMA ribbon, which is the red to yellow lines that are weaving in-between price action. These are 8 exponential moving averages from the length 20 to 55 in increments of 5. These can be used as indications for a number of things. They can act as support and resistance if price action is respectively coming down against the ribbon or moving up to the ribbon. And as I'm using them in this post, they can signal trend continuation and potential trend shifts. Whereas price action being below and above the ribbon signaling a continuation of the trend on that particular time frame.
There are factors that further validate the signaling of a continuation trend and these are if price action is to the either side of the ribbon for an extended period of time as well if price action is far below or above the ribbon. If price action falls below the ribbon or rises above the ribbon it can signal a potential trendshift, and then the same validating factors apply for the potential continuation of the trend. The EMA ribbon is generally more valuable for trend analysis on higher time frames, days to weeks as these are more validating for long-term trend continuation signaling.
Here is a graph of the SPX showcasing all trend shift signals, from the period of January 2022, on the daily chart using the EMA ribbon
As you can see there are also examples of false breakouts and breakdowns, where price action moves below and above the ribbon but does not continue in that trend. It is here where, if you were to solely use the EMA-ribbon, validating factors for a trend continuation comes in place. Which described earlier are when price action is developing in an extended period of time, rather than a day or two on the daily graph, to the side it has broken into. And a validating factor that can also be used is if price action significantly extends to the side which it broke into. This is one of the reasons that I also expect a continuation of the current downwards trend to significantly lower price action. I would also have a reason to reconsider my conviction if for example price action broke out above the ribbon and stayed above it for an extended period of time.
Keep in mind this is also a bit of a simplification as well as my interpretation of the usage of these indicators, so if you are interested I recommend you to read up more on the topic of these indicators. However, it is important to note that no indicator is perfect and, if they are to be used, they should be used as part of a larger trading strategy.
To add some thoughts and ideas that may dispute my conviction of a breakdown of price action, We have corporate bonds which generally speaking can be considered as "smart money" and be used as a divergence signal to the SPX. If you look at LQD which is the major Investment-grade bond ETF. We can see that it is picking up some steam and not showing short-term bearish divergence which one would be to expect during a bear flag pattern. Although it is also not showing a bullish divergence. It rests right now in the middle of the EMA ribbon on the daily chart, if it were to jump to the upside showing a bullish divergence to the SPX that would cause further invalidation of a short-term breakdown in price action and the opposite as well if it were to break to the downside.
You could also make the argument that since bonds have fallen so much compared to the SPX it is bound to pick up, as is the nature of money going from less-secure asset classes such as equities to more secure asset classes such as high-grade corporate bonds and treasury bonds (more the latter) during recessionary periods. Here is a chart showcasing the LQD relative to the SPX (LQD/SPX)
As you can see corporate bond prices have fallen significantly relative to the SPX ever since the 2008 financial crisis rising substantially only during covid. Also very interestingly the relative price has only reached the -2 standard deviation on the log-adjusted reg line one time during its entire price action history. It was in April of 2022. The only other time were it even came close to the -2 standard deviation was during the market peak mid 2007 approximately 1 year and 3 quarters before the absolute bottom of the '2008 financial crisis' Despite the fact that the corporate bond ETF LQD was at its highest price action during post covid it still reached the second -2 standard deviation relative to the SPX which truly highlights how overvalued the stock market is relative to bonds. A very similar, arguably worse, graph is shown with treasury bonds relative to the SPX (TLT/SPX).
This highlights the very real potential for bond prices to rise extremely high relative to the SPX, more likely treasury bonds than corporate bonds. But either way it highlights how much downwards potential there is for price action for the SPX.
I would also like to note that the LQD corporate bond ETF fell approximately -29% from its peak to the low in 2022, LQD also fell -29.5% during its lowest in the 2008 financial crisis. Compare this to the SPX which had its low in 2022 of approximately -28% from its peak and its low during the 2008 financial crisis which was approximately -57.5%. Corporate bonds are considered a lot more resilient than the SPX in periods of economic downturn. The idea that investment grade corporate bonds have bottomed lower than the SPX has historically not happened before which is highlighting my belief that the SPX still has a long way down to go.
LQD can also be seen as a lagging indicator meaning as the LQD recovers from its bottom, SPX has most likely not reached its bottom but will eventually do so as well. For example LQD reached its bottom during the 2008 financial crisis at the beginning of October of 2008 whilst SPX reached its bottom in the beginning of March 2009 approximately 5 months apart from each other. If you were to make an exact comparison to the 2008 financial crisis which LQD has bottomed (so far) to similar levels -29% vs -29.5% that would mean that the SPX would reach its bottom price action at 24th of march 2023. Mind you this is an exact comparison and markets generally do not tend to behave in this exact way regarding time periods, but it is interesting to compare.
The US10Y price action have mostly an inverse correlation to the SPX, And unlike the LQD it is actually showing a potential bullish divergence to the SPX where it recently went below the EMA ribbon on the daily showing a potential trend shift although it would probably need more price action to the downside to validate the potential trend shift.
I would not put as much value to this though as I would to the LQD. The reason being is that as time goes on the us10y will go down as inflation eventually comes down. whilst the LQD is an indicator that in my opinion can measure institutional investors as well as companies expectations for further corporate expansion. This is due to the fact that investment-grade corporate bond prices are partly dictated by corporates issuing new bonds, demand for corporate bonds by investors as well as expectations of the ability to generate future profits.
Regarding overall price action I'm firmly bearish for the long-term (months) with the SPX and QQQ even at these levels which some, especially the latter, may consider very low. But to give some perspective, this is a log-adjusted regression line from the end of 2021 to now for the QQQ.
The graph displays current price for the QQQ is firmly in the middle of the Reg line showing considerable short-term potential downside
To display even longer price action here is log-adjusted reg line from approx 1995 to now of the SPX
As you can see, there is significant potential for downwards price-action. I believe price action will most move closer to the -2 deviation of the reg-line if not reach it. This is under the assumption that a recession to the scope of my belief will occur (more on that in a future post).
This is log-adjusted reg line for the entire price action history of the QQQ showing similar downside potential
On a fundamental note a very important event is coming up at the end of the month (January 2023) which I believe regardless of future price-action until then will cause a massive fall in price action for the SPX, mainly Q4 earnings for 2022. I will discuss that as well in a future post.
As I finish this post I would like to thank you, the reader, for reading this, as this is my first post going into a more in-depth discussion regarding the market, more to come. I would also like to thank Trading view creator @SPY_Master for inspiring me to make this post, as well as inspiring me with his market analysis and methods. I highly recommend you check out his posts if you have not already.
F.Y.I not financial advice.
Credit Conditions and the Fed: Part 2In part 2 I take a quick look at high yield corporates and describe a common mistake made in using ETF ratios to monitor changes in credit risk. Part one and an earlier piece that described how to use the TradingView platform to monitor secondary market credit spreads are linked below.
If there is any one thing that will produce a Fed policy a pivot, it is credit distress. Credit is far more vital to economic functionality than equity. If companies are unable to secure funding, they may face liquidity issues, and if liquidity problems become widespread, they have the potential to become systemic. In 2008 and again in 2020 credit markets were frozen. Particularly in 2008, many companies ran into barriers that inhibited their conducting their ongoing daily business lines. There were plenty of offers but, as I so painfully remember, in many cases zero bids…. None…at any price. It was this credit distress that convinced the Fed to move.
In part 1 we looked at the weekly chart of the option adjusted spread (OAS) of the broad ICE BofA Corporate Index and concluded that the there is no evidence of the kind of credit distress that would galvanize the Fed, and that, at least on this basis, that there was no compelling value (rich/cheap) argument to be made.
What of high yield? Does high yield OAS suggest a meaningful deterioration in credit markets? Again, I plot a regression mean and one and two standard deviation bands above and below. Just as in the IG market, high yield OAS has widened, but only to its long term mean, and this following a lengthy period of being nearly a standard deviation rich. In short, while spreads have widened somewhat, there is no compelling rich/cheap argument and certainly nothing that would suggest to the Fed that credit conditions are meaningfully impaired.
I frequently see commentaries that use price changes in the high yield ETF (HYG) and the investment grade ETF (LQD) as a measure of investor risk preference. Since the January high, LQD is down 26.15% versus 19.65% for high yield. At first glance it appears as if investors prefer the lower quality HYG. But the price changes do not account for the differences in fund duration. Put simply, LQD at 8.36 years duration has roughly twice the interest sensitivity of HYG at 4.06 years. In other words, a 100 bps change in rate, will change LQD 8.36% and HYG 4.06%.
LQD in Ratio with HYG and Ten Year Futures in Ratio to Five Year Futures: I also see analysis that uses the ratio between LQD and HYG to ascertain risk preference. But the direction of the ratio is almost completely due to the difference in duration. You can see this by compare LQD/HYG to the ratio between ten year and five year note futures. LQD/HYG ratio is almost entirely correlated with changes between five and ten year treasuries. When rates are volatile and directional the total return of many rate products generally a reflection of rates than it is investor quality preference.
And finally, many of the topics and techniques discussed in this post are part of the CMT Associations Chartered Market Technician’s curriculum.
Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Taylor Financial Communications
Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.
Have corporate bonds bottomed?The Corporate bond market got extremely oversold and it bounced without the Fed having to pivot. Essentially the market got to 2013-2018 levels, and bounced nicely at the old support. But we still don't know whether the bottom is in or now, as there are more questions that need to be answered, like: Does the market expect the Fed to reverse course soon? Does the market think the bottom is in for bond yields? Does it think inflation has peaked?
In my opinion the market did the tightening itself without the Fed. The Fed did a mistake for not raising rates and ending QE faster, however they were right on their approach to go slowly, as one way or another inflation would slow down. By inflation slowing down down I don't mean that prices will go down, just that prices will go up a lot less than they did over the last 1-2 years. At the same time I do believe that as inflation comes down, it is possible that we get to see the Fed say that they will pause their hikes after raising them to around 2% and will let their balance sheet roll off on its own.
Essentially higher interest rates, lower asset prices, tight fiscal and monetary policy, and already high energy prices are crushing demand. The Fed was/is behind the curve, but as the curve seems to be now moving to the direction of the Fed. To a large extend their objective has been achieved, as this correction was similar to the 2018 correction, only that this time around the correction was welcomed when back then it wasn't.
Now I don't really think the bottom is in for corporate bonds, however I also don't think they are going to roll over very quickly. If the food & energy crisis gets worse, I have no doubt that these will get crushed. It just seems that in the short-medium term things will cool down a bit and part of them Fed's goals have been achieved. The US economy remains fairly strong and its corporations are in a fairly good shape, despite everything that has been going in the world over the last few years.
Having said all that I don't want to be a buyer of HYG at 80. At those levels I think it is better to short and aim for 77-78, and then if the price action looks decent, go long at those levels. The bounce is too sharp for it to have legs to go higher immediately. I'd expect more chop in the 75-81 area before the market decides whether it is going to go higher or lower.
Fed's Catch-22A Catch-22 is a problem for which the only solution is denied by a circumstance inherent in the problem or by a rule. This is exactly the problem the Federal Reserve faces.
Historic inflation continues to accelerate, becoming embedded into the market's expectations and risking a spiral effect
In order to stop rapid inflation, and achieve its mandate of price stability, the Fed must raise interest rates as rapidly as inflation is rising.
The Fed cannot raise interest rates as rapidly as would be needed to slow rapid inflation because it would rapidly begin to freeze liquidity in the corporate bond market.
Rapid tightening would spillover to corporate earnings, asset prices, consumer borrowing and spending, economic growth and ultimately employment, countering the Fed's mandate of maintaining stable employment.
The last time that investment grade corporate bond prices fell below their monthly EMA ribbon support was in March 2020, when the Fed made emergency purchases of corporate bond ETFs to ensure liquidity. Now the bond prices are falling below their monthly EMA ribbon support and the Fed is taking the exact opposite measure by calling for accelerated rate hikes.
Is it possible to avoid a recession at this point? Only time will tell but the charts seem to doubt it.
VIX vs TLT/LQD suggests bear is near. Back away slowly! VIX has been spiking with TLT/LQD, but the last few times just seemed to help turn it around. Looks similar to the new year, in orange. Volatility has been exploding, per usual. Every 2 years since 2008, Vix has made a new support 3pts higher, shown in solid white. I just read an analyst saying 18 is likely the bottom for some time. TLT/LQD has also been on a years long up trend as well, at a similar pace. So I'm inclined to belief this is a good spot to watch for a long scalp VIX entry, and shorts on the indices.
Credit - The Second Wave - EvergrandeIdea for Credit:
- Stocks had a bit of a reprieve as China's collapsing property firms were halted for 2 weeks, and China's markets had gone on holiday for Golden week.
- Stock market had an unwinding of hedges last week, but are things really 'Back to Normal'?
- The bond market does not think so, and seems to be presaging more drawdown to come.
- EM High Yield has been in capitulation, while US Corporate bonds and HY are accelerating their declines.
- High Yield Spreads are about to breakout.
- This is a problem that has not simply gone away, but rather will only get worse.
- Nikkei had even erased all losses of the year in 2 weeks, then lost them again in 2 weeks more, to continue its bear market:
- Remains to be seen how far-reaching the effects will be on China's 5T property market. The drag on global property market is real:
More to come on that later.
The stock market has its best days in bear markets as volatility increases, and this is really telling of the situation. I think we are already in a global bear market and recession.
110 1911 222
GLHF
- DPT
Bond yields keep fallingBonds all across the world, across all different spectrums (from gov bonds to junk bonds) have been rising (their yields falling). This is a signal that there are deflationary pressures and that people are searching for yield in an environment with few opportunities. There are other reasons too, but overall this isn't the best signal. Clearly big corporations and governments are benefiting from the situation, but this is also a fragile situation. Although the current conditions benefit some stocks and risk assets due to the highly negative real rates, this doesn't mean that everything is perfect. Personally I believe equities haven't topped and they have much more room to grow from here, but I also think a big correction isn't far away (10-20%).
In my opinion bond bulls are in control (bearish on yield) and yields could fall even lower.
Are the bond bulls in control or is it time for a break?Bonds have reached a very important level. For now this seems like a *logical* place for the *anti-reflation* / deflation trade to end, and for the risk on trade to be back. I am more on the disinflationary (very low inflation) camp, however bonds have risen substantially and it might be time to take some profits before the resume lower. I don't think we will have extremely high inflation yet and I don't think we will have the good type of inflation because things are going well. I do expect Oil to go higher and that to cause all sorts of issues and higher prices, but other than that I don't think bonds will get crushed. At least no yet.
The key question for the whole reflation trade is... WIll bonds and USD keep going higher, with only US behemoths rallying or and the rest bleeding or struggling, or could we get a larger shock? Because to me if the USD really breaks out and heads for 96 on the DXY, while bonds also rally... we will eventually see something break. I think we'll soon have a better idea of where things could be heading next so it is better to be patient and take a few select trades that go well with this environment and look technically sound.
LQD ShortLQD just bucked a very important trend line. If investors have indeed lost confidence in corporate debt and we see follow through, then I see this as a bearish signal for stocks too. Typically the bond market is known to be correct over the equity market as large institutions with more knowledge than retail traders deal with bonds directly. To see corporate bonds give up such a well defined, key trend line, is to me a signal to be short not only on LQD but on the markets as a whole. Recently, the ramp up in stock prices was on very low volume and I can count 10 unfilled gaps on the SPY ETF. On the graph, there is one instance where we saw negative divergences but the price corrected in time rather than in price. Here, we could definitely see a correction in price as support now becomes resistance with the trend broken.
I am not taking a short position on LQD directly but I do recommend taking short positions on equities through investment vehicles such as SQQQ (-3 QQQ). I am also considering on buying UGLD (x3 gold) and TMF (x3 US treasuries) as a flight to safety emerges into those safe haven assets.