Credit Spreads Narrowing = Good for Equities

The Junk / 20 Year Bond Ratio is showing early signals of continued if not increased appetite for stocks as an asset class. For anyone not familiar with this ratio, we're looking at HYG/TLT (or HYG/IEF which is also showing the same signs). In short here's what it means for you and me:

Falling Ratio = Credit Spreads Rising (bad for stocks)
Rising Ratio = Credit Spreads Narrowing (good for stocks)

Go back through any bear market or even just prolonged periods of consolidation and you will see this ratio hold true. When Stocks are showing risk appetite, we want Bonds (specifically credit spreads) to confirm. A rising spread between Junk and Government bonds helps confirm risk appetite for Stocks, and we are even seeing signs here that the ratio is breaking out of a nice base.

If the ratio falls back below the .69 area, that negates this thesis and we will re-evaluate as it could have broader, negative implications for the market.

For now, we have 2 initial upside targets at .82, then .92. As these targets are hit, we can expect stocks as an asset class (especially reflected in the indexes like the S&P 500) to consolidate or selloff a bit.

This also means the bout of selling we saw last week and potentially more in the coming weeks is a nice buying opportunity for long term holdings, but also for setups in short term trades and options plays. The selloff in bonds, at least for now, is not a worrying sign from a structural market perspective.

Stay patient, dedicated, and focused out there.


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