US yields have continued to collapse, with another hard leg down this month following July’s FOMC decision to cut rates for the first time since the Financial Crisis. A few weeks ago, I wrote about the 30-Year Yield pushing towards its record low of 2.10%. It fell as far as 1.92% in the time since and is currently consolidating below those key former lows.
Moving down the curve, the 10-Year is only about 20 basis points above its all-time lows from 2016 and the 2,3 and 5-Year are all pressing on their uptrend lines from 2012.
With the dominant trend clearly lower in Yields, this may be just the beginning for the bull market in bonds. So let’s dig in and see where the outperformance is coming from.
This is a ratio chart of High Yield Bond ETF, $HYG relative to the 3-7 Year Treasury Bond ETF, $IEI.
Prices bottomed in December along with equities but failed to rally back to resistance at the 38.2% retracement or trendline from its long-term consolidation, before rolling back over. The ratio has been in a sideways range for the past decade and is currently trapped below a downward sloping 200-day as prices press on their multi-year uptrend line.
This is a clear indication that Bond Market investors have been favoring Treasuries over riskier debt instruments such as High Yield, or “Junk Bonds.” And if prices violate their uptrend line, we’re likely to see this outperformance from Treasuries accelerate.
What else can this ratio tell us? Often analysts will point to the outperformance/underperformance in High Yield as a positive/negative for the stock market as it is evidence of risk-taking. But based on the price action over the past decade, this is simply not true. High-Yield has been trending steadily lower vs Treasuries since 2010-2011, yet the stock market is higher by roughly 150% during this time.
With that said, the ratio does tend to bottom at the same time as key stock market lows. Looking at the chart below, this was true for March 2009, October 2011, February 2016 and most recently December of 2018. But notice that these bottoms have all occurred after the ratio has collapsed and become very extended to the downside. This has typically coincided with harsh equity market selloffs which cause investors to flock into Treasuries for safety, thus depressing the ratio.
For example, while the ratio was a bit extended in December, it wasn’t even close to the extreme levels we saw during prior bottoms, as measured by price’s distance from the 200-day moving average. The same is true for today as the reading is at even less of an extreme than it was in December at just about -3.5%. In other words, this ratio is no where near signaling a bottom in equities.
So while there isn’t much insight we can gleam from this ratio for US Equities right now, it does illustrate an accurate picture of what is currently taking place in the Bond Market and overall economy. Consistent with the outperformance from other safe-haven investments such as Gold, Utilities and Yen within their respective asset classes, Fixed Income investors are also positioning defensively as they pile into Treasuries. Long story short, this ratio is telling us that overall risk-appetite is still very weak and that Treasuries are generating positive alpha in the Bond Market.
Hope you enjoyed this post! As always, reach out to me at Strazza@thechartreport.com with any questions or comments.