February WAS looking to be pretty good for the S&P 5001, being up almost 6% at one point this month. That is, until the last couple of days, when much like January, the market wanted to give back the gains. As of today, we are looking at ending February in mildly positive territory. But, if you take into account the losses from the end of January, we’re only slightly up for the year.
We are just not seeing the broad participation and conviction of all the market sectors to suggest a strong move higher from here. And by our measure, somewhere between 50 to 70% of stock market sectors are currently trending positive, depending on the day. In contrast, a “strong market” has 90%+ sectors trending positive.
But even more interesting is that there seems to be trouble again in the bond market. Most bond market sectors, from treasuries to aggregate bond indexes, seem to be struggling. The only bright spot has been high yield bonds, which have been holding up better as they tend to trade similarly to the stock market.
The volatility of the bond market leads us to think about inflation. When bond yields rise, bonds prices fall. Inflation could create this environment. Then the biggest danger relates to the duration of the bonds: the longer bonds have to maturity, the greater potential for loss as rates rise.
Inflation is its own rabbit hole, which you can go down here. It’s interesting stuff, but there are other metrics and data we find more effective in making investment decisions. If you’ve followed me for a while, you know that I prefer to “follow the money” above all else. Institutions and individuals alike vote with their dollars and that, I believe, is what actually moves the price of assets.
One of my favorite ways to look at market behavior is by using ratio charts – looking at a comparison of two different types of assets or asset classes to find trending behavior. This month, let’s look at the ratio of the S&P 500 and the Long-Term US Treasury bond index. The theory is if this line is rising, then the stock market (risk assets) is stronger than the bond market (safety assets). Whichever is showing strength can give hints as to what direction the market may take in the near term. This chart indicates that the market may continue to head higher in the short term.
Bonds – the bond markets started off the year in negative territory and still can’t quite seem to go positive. The Aggregate Bond Index AGG is down -2.26% Year-to-Date. High Yield was the bright spot, but has now gone negative for the year (FastTrack Data). Today, we are working to shorten the duration of our bond holdings to be ready if the interest rate situation continues to create a problem for bonds.
Sometimes the best course of action is to not play the game at all. In many of our models, we’ve spent more time out of the market than in it this year. Last month I mentioned we were hoping for a buy signal in February. We did get it, but it only lasted for 14 days. We are now back to being cautious in the near-term, but still somewhat optimistic in the longer term. Again, I think we could see another buy signal early in March, but who knows how long that will last. But if the longer-term data doesn’t strengthen soon, we’ll be reducing market exposure and risk to nearly nothing while we wait out the coming storm.
Stay safe out there!!
1 The Standard and Poor’s 500 is an unmanaged, capitalization-weighted benchmark that tracks broad-based changes in the U.S. stock market. This index of 500 common stocks is comprised of 400 industrial, 20 transportation, 40 utility, and 40 financial companies representing major U.S. industry sectors. The index is calculated on a total return basis with dividends reinvested and is not available for direct investment.
2 Charts are for informational purposes only and are not intended to be a projection or prediction of current or future performance of any specific product. All financial products have an element of risk and may experience loss. Past performance is not indicative of future results.