The Lead-Lag Report: Are Bond Markets on the Verge of a Meaningful Break?
We're at a key juncture, and the bias toward reflation remains. However, vigilance will be key in the coming weeks.
-- John C. Maxwell
Below is an assessment of the performance of some of the most important sectors and asset classes relative to each other, with an interpretation of what underlying market dynamics may be signaling about the future direction of risk-taking by investors. The below charts are all price ratios that show the underlying trend of the numerator relative to the denominator. A rising price ratio means the numerator is outperforming (up more/down less) the denominator.
For the full version of the Lead-Lag Report, click here.
LEADERS: BOND MARKET WATCH
Long Bonds (NYSEARCA:TENZ) – Yield Curve Steepening Continues
Comments: The yield curve appears to be in the early stages of steepening as longer-dated Treasuries begin to underperform shorter-duration ones. A steepening yield curve (declining ratio) would be a bullish indicator, suggesting that the reflation trade is accelerating. The ratio is now hitting up against support, and a break below would be important for a continuation of the uptrend in risk assets.
Treasury Inflation Protected Securities (NYSEARCA:IPE) – Steady
Comments: The IPE/TENZ price ratio is one way of seeing if inflation expectations are rising or falling within the bond market. When the ratio is trending higher, it means bets are occurring on rising prices ahead. Note that the ratio is having a hard time breaking past resistance, albeit the uptrend of higher lows remains. This remains an important ratio relationship to watch.
Junk Debt (NYSEARCA:JNK) – Tighter Spreads
Comments: The above ratio is one way of seeing if credit spreads are narrowing (uptrend in the ratio) or widening (downtrend in ratio). The ratio has made new relative highs, and may be in the early stages of a potential bubble. Spreads have narrowed and a downtrend does not have to be bad for markets so long as the speed of a potential turnaround is muted. This also remains an important relationship to watch for signs of cracking in risk-taking.
LAGGARDS: TECHNOLOGY HEMORRHAGES
Technology (NYSEARCA:XLK) – Support (Again and Again)
Comments: Technology is nearing another relative support level again after getting wrecked in the latter half of 2012. Weakness has been stunning since the late-August peak, and may be due for a period of outperformance upon confirmation. For a quick trade, technology is one to keep an eye on.
Utilities (NYSEARCA:XLU) – Breakdown Continues
Comments: Weakness in utilities continues on the heels of the fiscal cliff deal and overall risk-rotation taking place. Money continues to favor more cyclical areas of the stock market, which is a healthy sign for the continued uptrend in equities. If 2012 was the year of yield, 2013 likely becomes the year of appreciation.
Emerging Markets (NYSEARCA:EEM) – Time to Lag?
Comments: Emerging markets have performed quite strongly since September, holding up well as money favored overseas investments in the latter half of 2012. The ratio spiked to a resistance level and has since turned down a bit. A breakdown in the ratio appears to have occurred as money has rushed into overseas investments. I do not believe a big downtrend is likely, but rather that the US could simply stage a relative catch-up in strength.
Intermarket trends for the most part remain positive as our ATAC models used for managing our mutual fund and separate accounts stay in equities. The bond market appears to be at an important juncture, where either the yield curve begins to legitimately steepen, or credit spreads begin to falter after extreme narrowing. Which will take place is a function of the whims of the crowd, but the bias remains for reflation rather than another near-term deflationary scare.
Editor's note: This update is published every week exclusively for Minyanville, and is compiled by Michael A. Gayed, CFA, Chief Investment Strategist of Pension Partners, LLC.
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