High Yield Spread Supports Short-Term Market Rally
The rapid narrowing of high yield spreads over the last 3 days supports the idea of a significant short-term rally in the S&P500.
In the chart above, the top panel shows SPY over the last 1.5 years. The center panel tracks US high yield spreads as captured by the HYGH ETF (iShares Interest Rate Hedged High Yield Bond). This ETF tracks the high yield bond ETF, HYG, but is also interest rate hedged and is specifically designed to capture the high yield spread by removing the risk-free rate. High yield spreads generally track equity prices and can sometimes provide an early signal of changes in the equity market. I have previously posted about the spread using data from the Federal Reserve, but that data has a 1-day lag. The HYGH trades intra-day, so we can get a more up-to-date read. See link to the related idea below. Hat-tip to @MacroAlf for tweeting about this fund family recently.
We can see that over the last three days, there has been a significant move up (narrowing of spreads) in HYGH. The dotted yellow line shows how HYGH has moved above it's prior low, whereas the S&P500 is still below. Will the market catch up? The third panel suggests that it could.
In the third panel, I have provided the 5-day rate of change of HYGH so that we can identify rapid moves in the ETF. We can see that the large move in March coincided with a (counter-trend) move up in the index, likewise in November 2021. If we take a look at the longer history of this chart, we generally find the same result. There are very few occasions where a significant move in HYGH is not followed or coincident with a large move up in equities. On some occasions, a very large move (above 4) has signaled a market bottom (we are not there yet).
This indicator is not great for timing early entries, but it does seem to do pretty well as a way to validate a move up in equities. Note that this does not mean that we have hit a market bottom. The move up in March confirmed an existing rally which continued for a few weeks before rolling over. Given the bearish background, that might be what happens this time.
In the chart above, the top panel shows SPY over the last 1.5 years. The center panel tracks US high yield spreads as captured by the HYGH ETF (iShares Interest Rate Hedged High Yield Bond). This ETF tracks the high yield bond ETF, HYG, but is also interest rate hedged and is specifically designed to capture the high yield spread by removing the risk-free rate. High yield spreads generally track equity prices and can sometimes provide an early signal of changes in the equity market. I have previously posted about the spread using data from the Federal Reserve, but that data has a 1-day lag. The HYGH trades intra-day, so we can get a more up-to-date read. See link to the related idea below. Hat-tip to @MacroAlf for tweeting about this fund family recently.
We can see that over the last three days, there has been a significant move up (narrowing of spreads) in HYGH. The dotted yellow line shows how HYGH has moved above it's prior low, whereas the S&P500 is still below. Will the market catch up? The third panel suggests that it could.
In the third panel, I have provided the 5-day rate of change of HYGH so that we can identify rapid moves in the ETF. We can see that the large move in March coincided with a (counter-trend) move up in the index, likewise in November 2021. If we take a look at the longer history of this chart, we generally find the same result. There are very few occasions where a significant move in HYGH is not followed or coincident with a large move up in equities. On some occasions, a very large move (above 4) has signaled a market bottom (we are not there yet).
This indicator is not great for timing early entries, but it does seem to do pretty well as a way to validate a move up in equities. Note that this does not mean that we have hit a market bottom. The move up in March confirmed an existing rally which continued for a few weeks before rolling over. Given the bearish background, that might be what happens this time.
Comment:
TYPO: That middle chart should say INVERTED High Yield Spread, as it is represented by a bond fund. Sorry for any confusion!
Comment:
Intraday update: The spread is continuing to narrow today (HYGH is going up) and stocks are moving up in tandem.
