Are Credit Markets Leading Equity Markets…..Down?

The S&P500 dipped another 1.1% last week. Notably, this was the first back-to-back weekly decline since late 2012. Volume was light. In other words, investors weren’t all rushing out the door. At least not yet. Volatility, as measured by the VIX, jumped over 16%. That said, it is still nowhere near the levels associated with fearful, or chaotic selling. Investor complacency has not disappeared. Also not yet.

The US macro picture has not improved materially. The Case-Shiller home price index beat expectations. Sure, the government engineered housing price ‘recovery’ continues, but as soon as normal mortgage rates return (there is no way to argue that 3.5% 30 year mortgages are normal or that they will continue indefinitely), then demand from buyers will plunge,taking price back down to more normal market-driven levels. Meanwhile, the Dallas Fed manufacturing survey imploded. First quarter GDP growth missed expectations. Initial jobless claims jumped; they were supposed to remain unchanged. Personal incomes did not grow; consensus estimates called for a rise. And Personal spending fell; it was supposed to remain unchanged. Finally, yes, Chicago PMI was stronger than expected. But given the preponderance of other data points (all pointing south), this result looks like an outlier. A reversion back down wouldn’t be surprising next month.

Technically, despite the two-week sell-off, the S&P remains in an extremely over-bought range, especially at the weekly resolution. The index is still hugging all-time highs and remains well above its 200 day moving average. In fact, the S&P is still comfortably above its 50 day moving average. So it’s still far from breaking down in terms of price. Breadth, while also still strong, is showing signs of turning down. The percent of stocks above their 50 day moving average is weakening. And the summation index, derived from the McClellan oscillator is turned down strongly. The next couple of weeks will answer this simple question—are stocks dipping while not breaking their long uptrend, or are they finally breaking down and correcting in a more serious fashion?

Outside the US stock markets, an interesting story is developing in the fixed income markets. It seems that virtually all the major classes of bonds (corporate investment grade, high yield, US Treasuries, and municipal debt) are selling off notably. Long term government bonds (as represented by the TLT), are well below their 200 day moving average and more importantly, have turned the 200 day moving average down, so that they’re now in a downtrend. High yield bonds (using HYG) have crashed through 50 moving average support and are threatening the 200 day line, for the first time since 2011. LQD, the investment grade ETF, has decisively crashed below the 200 day moving average, for the first time since 2008. Finally, municipal bonds (using the fund MUB) have broken down below 200 day support, for the first time since late 2010.

Why does this matter?

Because there’s an old saying on Wall Street that bond often markets lead stock markets, because the ‘Dumb Money’ is mostly in stocks, while the ‘Smart Money’ dominates credit markets.

And today, the Smart Money is heading for the exits, for the first time in years. This is a very ominous signal. Let’s see if stock markets follow.

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