Two Out of Three Ain’t Bad
Igor Manukhov - May 05, 2025
The recent rally has been very constructive and is beginning to look like a true recovery. Use market weakness as an opportunity to accumulate assets.
After a bizarre start of the month, stocks are recovering in a dramatic fashion. We have successfully moved through a very important resistance level at 5500 (marked by a horizontal blue line). The next milestone would be March high of 5800 (horizontal green line). While price action is encouraging, it is critical to look “under the hood” of the market to access its resiliency.
When the market rallies, I expect to see confirmation from certain indicators – just like we expect a thermometer to show warmer temperatures when it’s hot outside.
Some of my favourite market indicators are the following:
1. High Yield Bond Spread (orange line): This indicator measures the premium that junk bond holders demand over and above government bonds. If government bonds yield 4% and this spread is 4%, then junk bonds pay 8%. This spread changes based on market conditions and attitude of investors. The spread increases during uncertain times and typically declines when market rallies.
2. Bullish Percent Index (pink line): Think of the stock market like a hockey team – you want everyone to pull their weight to increase your chances of winning. If only a few players pull the entire team, the team’s strength may not be sustainable. This indicator measures how many stocks in the S&P500 are rallying at the moment. This indicator fluctuates between 0% and 100%. The more the better. I expect more stocks to pull their weight during market rallies.
3. Relative Strength of Discretionary Stocks vs Staples Stocks (blue line on the bottom panel): Discretionary stocks represent "wants" (like luxury cars or iPhones), while staples represent "needs" (like toilet paper). In tough times, consumers cut back on wants, so staples outperform. In better times, discretionary stocks tend to lead. A shift toward discretionary strength signals growing confidence.
So far, the market bottomed on April 8th, marked by a vertical blue line on the chart. Notice how indicators have been changing as prices began to recover. Spreads went down (orange line), and more stocks joined the rally (pink line has been rising). The only missing piece is leadership from discretionary stocks—people still seem to prefer toilet paper over luxury cars for now. But two out of three isn’t bad.
I believe that the recent rally is a promising sign. While we might see more volatility, I would recommend to use any market weakness going forward to accumulate great assets at discounted prices.
