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No End to the Demand for Corporate Bonds


DeMark Indicators and the corporate bond market share the same message about equities.

Last week, I looked at several DeMark indicators applied to the S&P 500 Futures (SP1) pit contract. My conclusion was that stocks might be in for a bit of a rough patch in the near term, but further out, the trend remains pretty solidly bullish. This jives with the state of the corporate bond market, which I submit to you is the linchpin for higher stock prices, since it is the sale of corporate bonds that funds companies' buybacks, and since on a net basis, corporations are, and have been for years, the only net buyers of equities (you can look at Table F.213 of Publication Z.1 for data).

So this week, it is worth looking at four key tells concerning the health of the corporate bond market: credit default swaps on major US financials; a generic CDS index on high-yield bonds; high-yield rates; and, most importantly, corporate bond issuance.

After the CDS of major US financials recovered from the June spike, which conveniently coincided with the S&P 500 (INDEXSP:.INX) 7% correction, the spreads have remained fairly steady. This CDS subset is a favorite of macro bears, so the fact that it's remaining fairly quiet suggests that these players aren't buying into all the omens (Hindenburg and otherwise) surrounding equities.

About the same can be said of the Markit CDX North America High-Yield Index, a widely followed index of CDS on US junk bonds. If anything, it may be worth noting that this indicator has been improving of late despite the drop in stocks.

The third chart shows the Barclays US Corporate High Yield Index. I've shown the weekly chart of this index in past articles to suggest that since the end of the financial crisis, it has not managed to establish a single upward trend, which I define as a completed De Mark TD sell setup. The story continues, and the current count has a long way to go before completing. One yellow flag is the proximity of the weekly TDST level up to the current price. However, that's almost inevitable since the relentless completion of buy setups establishes ever lower resistance. I'd be more concerned if spreads were to break the monthly TDST level up at 735bps.

The real story, of course, is what is happening in the corporate bond issuance market. You can slice and dice the numbers however you want, but the only conclusion is that the appetite for new bonds remains insatiable. According to the Bloomberg LEAG tables year-to-date, approximately $1.024 trillion of new bonds have been sold in the US, versus approximately $953 billion last year. Moreover, if you flip through the biweekly Pensions & Investments publication, you will read all about the persistent allocations of new money to corporate funds and to real estate funds. (This raises the question of what may happen to equities of REITs down the line, despite the rise in Treasury yields. Keep an eye on the iShares US Real Estate ETF (NYSEARCA:IYR), though this is a subject for another story.)

Throw in the increase in well-received covenant-lite offerings (even in Europe), the flood of money into US leveraged loan funds (much driven by the floating rate nature of these securities), and the steady issuance of CLOs and CDOs, and good luck making the argument that the corporate bond market is in dire straits.

Bottom line: Only in hindsight will we know if the current dip in stocks is over, but consistent with longer-term bullish DeMark setups for stocks, corporate bonds suggest that the run for equities is far from being over.

Twitter: @FZucchi

Editor's Note: At Minyanville we often argue that markets and stocks are driven by four primary attributes: the fundamentals, the technicals, the structural, and psychology. In this weekly piece, trader Fil Zucchi will attempt to digest these four measures to come to actionable recommendations, but with a couple of twists: Rather than relying on standard technical analysis, he will examine the technicals through the lenses of "DeMark" indicators. And rather than highlighting straight entry and exit points for stocks, he will use options to gain long / short exposure, control risk, and generate cash flow. Investors should note: This column will be written 1-2 days prior to publication, so by the time it appears the prices of the securities mentioned may have changed.
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