Measuring Market Sentiment with Bond Returns

• Posted by scheplick
• on June 12th, 2012

In January, DynamicHedge posted a chart that compared liquid bond returns to large cap equity returns. The chart found its purpose in its ability to measure the mood of the market based on the returns from stocks and bonds. Is the market bullish? Or is it bearish? Well, that depends on where the cash is glowing, and what asset class (stocks or bonds) is returning more of it. Have a look at an excerpt from his post here, and the chart after the jump:

The indicator below does a great job of keeping you on the right side of the big market moves.  The blue line on the chart represents a proprietary indicator measuring the skew of a multi-asset spread ratio of large cap equity returns vs liquid bond returns.  When the skew line is above zero it means that funds are flowing into risk assets.  When the skew line is below zero it means that investors are more risk averse [funds are flowing away from risk assets].

 

 

(To view the chart created by Dynamic Hedge on a longer time frame, click here. This chart dates back to 2003.)

Like our last post at The U, which touched up on Treasury ETFs, the take away is to watch bond prices and their returns because their prices will tell you the market’s appetite for risk — whether investors are seeking a high risk high return in stocks, or low risk low return in bonds. Looking at the flow of bonds will help you better understand the state of the markets.

If you do not have access to a chart similar to the one created by DynamicHedge, the natural alternative is to watch treasury ETF prices. There are short, medium, and long-term treasuries $SHY, $IEF, and $TLT, and an array of corporate bond ETFs like Junk Bonds $JNK, Investment Grade Bonds $LQD, and Short-Term Corporate Bonds $VCSH.

In terms of your investment strategy, before you make your next big investment or trade, check the bond market … You don’t want to get caught buying stock on the wrong side.

 

 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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