Corporate bond spreads have been in sync with the market up until January 2018. Since then they have been diverging and warned of the Q4 correction.
Of note is the divergence this month, signaling the market has likely gone further than it should. Bond spreads are more closely aligned with the weakness displayed in small caps, which have less buying support as stock buybacks play a larger role in the larger cap indices.
Companies keep buying huge quantities of their own shares, propelling prices higher even as pensions, mutual funds and individuals sit on their hands…
This year alone, Goldman Sachs analysts estimated, corporations will be by far the largest buyer of shares, with net purchases of $700 billion. Traditional investors like mutual funds, pensions, endowments and individuals are expected to be net sellers, parting with roughly $400 billion in shares.
One of the areas of concern cited by the Fed last year was the leveraged loan market, which took a nose dive in Q4. This space had a strong Q1 rally but has since peaked and is rolling over again.
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Looking at corporate credit default swaps (CDS) there is a noticeable change in trend over the last few weeks that could be hinting at a corrective period ahead.
Of note is that 1-month and 3-month new lows on the Russell 3000 this past week have exceeded the levels from the early March decline while new highs have been moderating, signaling a thinning market that is eroding under the surface.
Looking at the internals of the Russell 3000, the expansion in new lows on a 1-month and 3-month basis looks to be highest among health care, industrials, and tech, which carry some of the largest weights within US indices while new highs are in defensive sectors like REITS and Utilities.
While many technicians are citing new highs in advance-decline lines, cumulative new highs-lows tells a different story. The ADL for the Russell 3000 retested the highs seen last year while cumulative new 200-day new highs-lows has barely budged off the nadir seen in December of last year.
Despite the market’s strong run this year, more than half of the S&P 500 members remain 10% or more off their 52-week highs and nearly a third of the market remains in a bear market, similar to the dynamic we saw with the Q4 2015 rally off the summer lows prior to the large Jan-Feb 2016 decline.
If we look at a more broad-based index like the S&P 1500 (small, medium, and large cap) we see that the percent in bear markets is increasing yet again and never materially fell. The lowest the percent in bear markets fell to during the rally (~ 40%) was roughly the peak seen in the initial 2015 decline, not exactly encouraging and we are back to nearly 50% of the market is in a bear market.
Looking at the internal momentum of the market, the percent of S&P 1500 members with monthly MACD buy signals had an incredibly weak recovery, similar to what we saw with the Q4 rally in 2015 and unlike the dramatic recovery seen in H1 2016, suggesting the corrective period that began in Q4 2018 is not yet over.
If we do move into a corrective period, the large cap space has a lot of room to fall.
Mid caps look to be half way there towards an oversold condition.
While small caps are even further along in their corrective period.
Bottom line: The message from the internals of the market suggest caution over the coming weeks/months.