Bank of America
The bond market just flashed a bullish signal that suggests a risk-on environment for stocks.The bullish signal is based on risky high-yield bonds outperforming relative to corporate bonds.This is the second longest stretch of outperformance for high-yield bonds, according to Bank of America.
Our Chart of the Day is from Bank of America, which highlights that the bond market just flashed a bullish signal that suggests a risk-on environment for stocks.
The signal shows that risky high-yield corporate bonds just hit a relative high against safer investment-grade corporate bonds, signaling that bond investors are growing comfortable with taking on more risk right now. The ratio between high-yield and corporate bond performance has exceeded its high set in February 2001, according to the chart.
“Last week’s move to a new high confirms this risk-on leadership, extending the bullish cycle for high-yield vs. investment grade [bonds] to 177 weeks from the April 2020 low. This is the second longest bullish cycle… since the October 2002 to June 2007 cycle of 243 weeks,” BofA technical analyst Stephen Suttmeier said.
The outperformance of high-yield bonds relative to their safer counterparts like investment grade corporate bonds and even Treasury bonds coincides with the continued decline in the BofA high-yield option adjusted spread, which shows that bond market investors are not as concerned about the economy as stock market investors are.
“We view this as a risk-on bullish leading indicator that favors eventual new year-to-date highs on the S&P 500,” Suttmeier said in a note last week. “Constructive credit markets entering September support the case for the bullish seasonality scenarios that we have highlighted.”
Bond market investors are usually the first group of investors to grow concerned about a deteriorating macro economic environment, well ahead of stock market investors. So as long as bond investors keep their cool, that should bode well for the broader stock market.
Previous cycle highs in the relative performance between high-yield and investment grade corporate bonds include October 2018, December 2013, and April 2011. Stocks went on to generate big returns after those cycle highs. But this indicator isn’t a 100% guarantee of anything, as prior cycle highs in June 2007 and February 2001 occurred right before a slowdown in the stock market.