Equities have somewhat continued their uptrend, although it looks more like
trudging along than any real sustained strength. This is a sign of weakness.
More importantly, we may be in for a bumpy ride in stocks for a while if we
take a closer look at some of the underlying dynamics. Beneath the surface,
things look quite shaky: credit is diverging, and sector rotation tells us
investors seem to be favoring more defensive assets. Let’s talk about it.
Sometimes to investors and traders it feels like stocks move in isolation,
but they respond to signals from other asset classes behind the scenes.
Credit, for one, is usually a leading indicator of what equities will do, as
it reflects changing expectations. If we look at the credit markets, they
are flashing some warning signs. Take a look at the chart below. Both High
Yield and Investment Grade corporate bonds haven’t confirmed the strength in
equities over the past few months. While this isn’t grounds for panic,
healthy bull markets in stocks tend to be accompanied by improving credit
performance.
Looking further, sector rotation suggests investors are leaning more toward
defensive stocks. When we look at the Discretionary vs. Staples ratio, we
see the divergence clearly. It’s one of the best ratios to gauge how
investors view the market and its expectations. What we’re seeing now isn’t
a particularly good sign for the foreseeable future.
It has become difficult to gauge what the markets will do lately. We’re not
in a clear macro regime either. The Fed is still in a long-term cutting
cycle, but its balance sheet is shrinking. Add to that the possibility of a
changing of the guard, as Powell might be replaced by Warsh. The key
takeaway, as always, is to follow the trend. But the shakiness underneath
warrants extra vigilance in the short to medium term.
So, what do you think? Are we heading for a correction in equities? A bear
market? Or maybe even a recession? Write down your opinion in the comments
below or let me know via the
contact form!