Not All is Bad
Igor Manukhov - Jan 13, 2025
If the bond market is not worried, the equity market will likely carry on.
It seems like stock investors were a bit naughty this year, and we did not get the usual Santa Claus rally in December. Indeed, the market is struggling to rebound from a mini selloff last month. Due to the recent volatility, more and more people have been asking me if the bull market is over and if the market will lose money this year. I looked at the chart and this is what I see:
1. The market is still trending upwards.
Despite recent struggles, the market is still trending up. The black line, representing S&P500, is trading above rising 30-week moving average, shown as the blue line. If this continues, we are still in a bull market and any short-term selloffs should be treated as buying opportunities. Notice how the market tends to rebound when the black line approaches the rising blue line.
2. Distinguishing short-term pullbacks from bear markets
The bond market can be very helpful in identifying the difference. Bond investors are more risk-averse than stock investors. Because of this, bond investors start to move to safer assets before the stock market starts to decline. A key indicator to follow is the high-yield bond spreads (the red line on the bottom panel). The spread shows the yield premium that junk bond holders receive over government bonds at any given time. When markets are stable, those yield spreads are quite tight. They expand during times of a crisis because bond holders demand much higher yields during bad times to compensate for increased risks.
For example, a reading of 10 indicates that, at that time, high-yield bonds were paying 10% more than government bonds (e.g., if government bonds yield 3%, high-yield bonds would yield 13%).
I have marked previous instances of high-yield spikes on the chart. As you can see, they closely align with previous stock market selloffs. Currently, the high-yield spread is at one of its lower historical levels. I would not recommend selling stock before the bond market starts to show signs of concern and these spreads begin to rise.
