High Yield Spreads Signal S&P500 Capitulation!
The ICE BofA US High Yield Options-Adjusted Spread is a measure of the risk premium demanded for high yield (junk) bonds. It is published at the end of each day by the St. Louis Fed.
When it is elevated to high levels (above about 4.5%) it can act as an early warning for equity prices. See the horizontal orange line in the middle panel. Last week, on May 11, the HY OAS crossed above 4.5 for the first time since 24 Feb 2020. That was the first early warning signal.
The bottom panel on the chart shows the 10-day rate of change of the HY OAS. Why? Because it's not just the level that is important. When it is ramping up quickly, that provides an more ominous signal. The indicator has crossed up above the horizontal orange line (20.66) three times since 2008. In 2008 and 2011 that coincided with general capitulation starting in the S&P500. It was arguably early in 2020, catching institutional capitulation. General capitulation followed a few days later.
The ROC indicator signaled on May 12 briefly but dropped back below the signal line the next day. That was the second early warning signal. Today, the indicator has again crossed above the signal line. I interpret this as a particularly strong signal as it has now been tested.
In short, I expect general capitulation in equity markets to start today. Certainly the price action so far supports that thesis! The next few trading days should have extending breadth to the downside. Don't buy the dip just yet! This is a falling knife!
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When it is elevated to high levels (above about 4.5%) it can act as an early warning for equity prices. See the horizontal orange line in the middle panel. Last week, on May 11, the HY OAS crossed above 4.5 for the first time since 24 Feb 2020. That was the first early warning signal.
The bottom panel on the chart shows the 10-day rate of change of the HY OAS. Why? Because it's not just the level that is important. When it is ramping up quickly, that provides an more ominous signal. The indicator has crossed up above the horizontal orange line (20.66) three times since 2008. In 2008 and 2011 that coincided with general capitulation starting in the S&P500. It was arguably early in 2020, catching institutional capitulation. General capitulation followed a few days later.
The ROC indicator signaled on May 12 briefly but dropped back below the signal line the next day. That was the second early warning signal. Today, the indicator has again crossed above the signal line. I interpret this as a particularly strong signal as it has now been tested.
In short, I expect general capitulation in equity markets to start today. Certainly the price action so far supports that thesis! The next few trading days should have extending breadth to the downside. Don't buy the dip just yet! This is a falling knife!
Please follow me for more market insights!
Comment:
Well, the OAS has backed off from 4.92 all the way down to 4.91... Still well above 4.5, and still elevated. The ROC indicator has dipped back below the signal line. Let's see what happens over the next few days.
Comment:
The OAS has backed off a bit more to 4.82. This is still elevated, but has allowed the ROC to drop back further. We may need another run at this to confirm a capitulation signal. The market looks set for a short-term counter-trend rally to shake out some bears.
Comment:
The HY OAS increased to 4.94 yesterday, which is a new high. But, the ROC is continuing to go down. What does this mean? It means that the HY OAS is signaling caution for now, but that the capitulation signal was probably a false signal. There should have been follow-through, but there was not. This happened in 2018 also...
Back then, it signaled a market bottom. That could be happening here. I'm seeing price action that suggests we get a local rally, at least. We will need to see how the next week or two unfold.
Back then, it signaled a market bottom. That could be happening here. I'm seeing price action that suggests we get a local rally, at least. We will need to see how the next week or two unfold.
