Credit Check

US equity markets stuttered just a touch to start the week. Nothing much, but it did manage to knock four points off of the VIX Mix. Still in the green with 11 of 17 components also bullish and only two on the other end.

It would certainly make things feel even better if the Mix could stretch back into the higher 70s but at least the trend has once again become a friend.

With equities stretching to new highs again, I thought it would be a good time to check in on what our credit market canaries are telling us. First up is our chart of the cumulative advance-decline line for high yield bonds. For those new to our blog, this data comes from FINRA and tracks traded high yield securities. As such, it excludes what has come to be known as private credit. Still useful IMO. What we’re seeing right now is a deterioration in the A-D line and a bearish divergence with the rally for SPX. While this does not mean that stocks will crash, it does indicate that junk bond investors have lost some enthusiasm for that category of risk-on assets. We are paying attention to the possibility that this bad attitude could spread to equities.

Switching the focus from junk bonds to those of higher quality, this next chart uses the ratio of investment grade corporate bonds (LQD) to Treasury bonds of similar duration (IEF). While not perfectly correlated with the S&P 500, a rising LQD:IEF ratio says that investors favor the riskier corporate credit while a falling ratio suggests that they’re reducing risk in their portfolios. As with high yield bonds, the current attitude is risk-off. Maybe people are selling bonds to buy stocks. Perhaps our credit market canaries are telling us to be careful.

In short, equity markets are bullish and the volatility complex has improved to a place that favors risk-on positioning. But the damn credit markets are not on the same page. Stocks and bonds need to get back in sync. That can happen one of two ways - bonds go up or stocks go down. You might want to have a plan for both scenarios.

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