What I am Watching

Global stocks have bounced significantly off the lows set in mid-June, yet they are still a long way from getting back to where they started the year. Inflation is stubbornly high, and the Federal Reserve is intent on hiking interest rates to help lower inflation. It seems like you could make an argument for the next 15% move, be it 15% up from here or 15% down from here, and either argument would have validity. Here are some charts I am watching to see where things may be headed.

This is a chart of the US High Yield Option-Adjusted Spread. Essentially, the number on this chart is the difference in yield you receive from purchasing junk bonds when compared to the yield on US Treasury bonds. In theory, investors should get a higher yield on junk bonds due to the high risk of default when compared to US Treasuries. If you think a highly leveraged company will default on its debt, you would rather buy US Treasury bonds would push the spread higher. If you think a highly leveraged company will be able to pay the interest and principal on their bonds, then you would buy those bonds instead of treasuries which would push this chart lower.

We can see that at the start of the year, investors in junk bonds were getting about 3% more yield in junk bonds when compared to treasuries. As fears of a recession increased, investors sold junk bonds which cause the spread to double to 6%. The spread topped out on July 6th and has been on the decline ever since. Continued weakness in this chart would show that investors’ appetite for “risk” assets are high and that odds of bankruptcies caused by a recession are reduced. If this chart starts to go up again, it will tell us that investors are becoming risk-averse and that odds of a recession are increasing.

This is a chart of the national price of regular gasoline so far in 2022, combined with the last full three years of price changes. The Federal Reserve has stated that it is not on a “set path” to raising interest rates and that it will be “data dependent” when making interest rates decision. That makes this chart particularly important because the price of gasoline goes directly into the monthly Consumer Price Index which is an inflation data point that the Fed watches closely. We can see that prices have risen sharply in 2022. However, we can also see that gas prices have dropped roughly a full dollar from their highs in early June. (Also, note that the chart of 2022 gas prices is oddly similar to the previous chart of high yield spreads – both rose sharply from April to June and both topped out in the first week of June.) Where this chart goes next gives us a big piece of the inflation “puzzle” and may indicate how aggressive the Fed will be in hiking interest rates.

The above chart* shows the S&P 500 index** in the top panel with the percentage of stocks in the index that are above their 200-day Simple Moving Average (SMA) price***. We can see that the percentage of stocks in the index above that moving average rarely gets below the red 15% line – it takes a pretty significant sell off to trigger that number. Once the that number rises back above 15% there seem to be nice gains ahead, depending on the time frame. The current percentage of stocks in the index above their 200-day moving average is now at 35% after having dipped below the 15% threshold in June. I will be watching this chart to see if the percentage of stocks above the 200-day moving average continues to expand.

* This chart is borrowed from All Star Charts – https://get.allstarcharts.com/. They do great technical analysis work that I follow daily.

**The S&P 500 is an index. You can not invest directly in an index.

***The 200-day Simple Moving Average is calculated by taking the closing price of the index (or any security) on every day over the last 200 trading days, adding those prices together, and then dividing by 200.

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