Brian Reynolds, on treasuries, spreads, and other things
Following the change of language at the January Fed meeting, we noted that investor sentiment had changed and that the equity markets were in a correction. Two weeks ago, we noted how this correction had a number of similarities to the one that occurred from mid-June of last year through August, and now we are seeing even more similarities.
In February, we noted how, after a strong rise and a long period of overbought stochastics, the S&P topped out in mid-June, as was the case with the S&P in mid-January. In both cases, the longer-term stochastics then went from overbought almost (but not quite) to oversold, then the market rallied to put in what appeared to put in a double-top, with the peaks about a month apart. Following the double-top, the market began to sell off again, as that technical pattern emboldened bearish investors (which brought us up to when that column was written in late February).We then wrote: "If the similarities between the two periods were to hold, this current selloff would accelerate over the next few weeks, with the S&P piercing support. That would further embolden the bears, but would also push the stochastics to an oversold level sometime in late March, setting the stage for a resumption of equity gains."
Well, that scenario has played out, with the S&P breaking support in the 1125 area while the short-term stochastics have just entered oversold territory, and we are finding more similarities between the two corrections:
-In last year's correction, bearish investors were pointing to the lack of job creation. Last Friday's payroll report has renewed those concerns.
-The soft payroll report on Friday caused bond yields to break below critical support, causing a large number of mortgages to become refinanceable and sending mortgage managers to scurry and buy even more Treasuries to hedge themselves. In last year's correction, we were in the midst of a similar Treasury buying frenzy.
-Corporate bonds have held up well in both Treasury rallies, allowing most of the impact of the Treasury bond move to flow through to corporates.
Given that last summer was the first time in 5 years that both corporate and Treasury buyers were applying stimulus together, leading to higher stock prices once investors realized the impact of those forces, it stands to reason that the current dual stimulus will eventually have a similar impact on equity prices. Given that the short-term stochastics have just entered oversold, and the slower stochastics have a way to go before they get there, it may take some more time before the correction ends. But, the longer that the fixed income markets are aligned this way, the greater the odds are that we will eventually see higher prices.
We also wrote that we need to be alert to forces that would change our opinion, as history doesn't always repeat exactly.
We were appearing on Bloomberg TV early yesterday morning when news of the horrible attack in Spain was breaking. At the time, the newswires were indicating that it was the work of a separatist group, and the equity futures were down only slightly. We said on the air that, whether terrorism is regional or global, it is a serious concern. However, we also added that investors have had nearly three years to think about terrorism worries. We've written in the past that we know there are people who are trying to destroy capitalism and who would love to try more attacks; the question for investors is how successful any attack will be at disrupting commerce; even the massive 9/11 attacks only disrupted the economy for a short time.
From that standpoint, while yesterday's attack elevated worries amongst equity investors, corporate bond investors were more sanguine. Investment-grade spreads were only 1-2 basis points wider, while junk spreads were only 4-5 basis points wider. So, the reaction in corporates was more muted than in the equity market. As long as the corporate market remains healthy, it should limit how bad equities can get. Otherwise, we would expect LBO activity to markedly increase. Should the corporate market worsen significantly, however, it would increase the odds that the equity correction turns into something worse.
Side note:
It was a year ago today that we noted that the longer-term stock/bond technical momentum indicators that we watch had moved so in favor of stocks that there was the possibility that we might see the beginnings of the bond-to-stock trade. That day turned out to be the low for the year, as the subsequent news flow from the war encouraged more of that trade to be put on.
Since then, these indicators have not produced much of a meaningful signal, as the subsequent outperformance by stocks over Treasuries has been more or less a constant through February. In the last few weeks, though, stocks have substantially underperformed Treasuries. While the momentum indicators that we look at are not yet back to the levels of a year ago, some of them are at their most favorable level for stock outperformance against Treasuries since late March/early April of last year. |
