Keep an eye on the bond market

Macron’s Victory was greeted with indifference by equity and bond investors on Monday. A muted reaction to what is considered a positive piece of news is described as the travel and arrive effect. The outcome was expected and the market had priced the event in. Equities remain resilient as the Vix index reached a low on Monday of 9.67, more than a ten-year low on an intraday basis. The next low is 9.39 in 2006, and the low from the start in 1992 was 8.89 in December 1993. The equivalent index for treasury bonds fell to a 7 week low. Equity and bond markets apparently feel confident that the Federal Reserve’s recent minutes, suggesting a bounce back in the US economy in the second quarter is on track.

Warren Buffet advocates getting fearful when everyone else gets greedy, which has served him and those who follow that philosophy well. The Vix index is considered by many a gauge of fear and greed and at close to record lows suggests excess of greed. On the flip side, real bond yields for many developed economies remain negative, suggesting a level of fear remains.

Yardeni Research produce a table of other stock indicators that can provide further evidence as to market sentiment. Studying some of the other indicators to equity sentiment, Investors Intelligence, Bull Bear ratio’s and the AAII investor sentiment. S&P 500 put call ratio, a measure we sometimes quote, alongside such technicals as the relationship between the death and golden crosses. Overall the Yardeni’s studies appear to suggest that many historic measures of sentiment are in neutral territory. For example, if one looks at the AAII weekly investor bull/bear measure. The bull, bear and neutral readings are almost bang on historical averages. It is also worth noting that sentiment indicators seem better at picking troughs rather than peaks.

Looking at other measures such as the Yardeni global growth barometer against the S&P 500 both correlated very well through the 2000’s up until 2012. However, had an investor had based his investment decisions on this barometer from 2012 it would have been a mistake. Equities have continued to rise the growth barometer has not. The Citi economic surprise index has fallen of the well-worn cliff recently, despite this, equities have remained resilient. These facts may suggest that greed has picked up.

Equity investors may start to pay more attention to the US treasury market, even though yields remain close to their historic lows, yields on the ten-year note rose to a five-week high of 2.41% on Tuesday. Yields on German bunds have also crept higher in the past few days, however at 0.43% they also remain very low compared to history. Should volatility pick up in the bond market this may well feed through into equity prices.

Posted on May 10, 2017 .