HYG-TLT Ratio Breakout

New all-time high. The argument for a breakout is that we get a sovereign debt crisis that takes U.S. government bonds down more than corporate bonds, including junk. HYG also leading against investment grade bonds in LQD though. That only makes sense if the economy is much stronger than the data reflects. Place you bets.

With dividends stripped, the ratio also broke out.

A case can be made for HYG outperforming TLT in an inflationary environment that is also strong economically. The converse view is the oversold reading suggesting a reversal. HYG is sitting above long-term support, while TLT and LQD have broken down. As a ratio trade, I'd look for a reversal in the ratios. Whether that is more long TLT or short HYG I can't say for certain, but I'm buying puts on HYG.

Tight stops. I expect a downside move to be almost immediate.

High Yield Debt Still in Positive Divergence

Amazing that high-yield is diverging positively from investment grade bonds even as it has been moving lower. Positive divergence the past few days as well.

On the Precipice

Credit Risk is Bottoming

High yield bonds are becoming precariously priced.

Credit risk is getting compressed as bonds continue weakening. Either we're entering a new era where high yield credit leads the market (that's what a breakout on these charts would indicate) or high yield is at increasing risk of a "plug pull" moment should credit risk rise. Since bonds are falling, the risk inherent in high-yield bonds won't simply rise in step with credit risk, but will suddenly catch-down to the slide in treasuries.

The ex-dividend chart shows a consistent decline in high-yield credit. Unless there's an economic boom around the corner, these charts also paint a bearish picture. The relationship with TLT is interesting though. It makes sense that HYG would spike when TLT is low, but through this lens, we can see that the relationship is also stretched. Putting all the above charts together, I think its safe to say that in relative terms, credit risk is bottoming.

Credit spreads, including the investment grade spread:

These charts provide the final context. Credit risk is not only elevated, but it is approaching the sell everything line for the stock market. Yet in relative terms compared to a portfolio of government or corporate bonds, high-yield debt is reaching resistance. It has stealthily diverged because this cycle didn't include economic risk (yet). 

Bonus: here is the high-yield spread vs the ratio of IEI to HYG (inverse of above). It shows the gap I'm talking about. 

If I had to pick a "you are here" candle, it would be October 2018. A similar setup with a stock market decline, bonds falling, but the bond market starting to look for a pivot. HYG would lose about 6.5 percent into December. I suspect much larger losses are in the cards this time because the macro setup is an echo of 2008: rates are elevated, but credit risk will jump as interest rates fall in a recession. Conversely, if you forecast falling interest rates without any rising economic risk (Goldilocks returns), then perhaps the low for stocks is in and happy days are here again for bulls.

Investment Grade Corporate Bonds at Pandemic Panic Lows

Strip out dividends and LQD is near its 2020 low. If this looks like a bounce to you, buy TLT instead because TLT will bounce if credit risk rises, but LQD and other corporate bond funds will not. In a bear scenario, rising credit risk offsetts a dip in rates and the spreads on corporate bonds blow-out as in March 2020 or 2008. I have opened an OTM call position on TLT for October. Stop right under the 52-week low.

Capitulation Day 1 or Economic Collapse Incoming

There's not much to say because in these situations, the selling stops when it stops. Anytime is a good time for a low. Since the market closed near the lows, the final low might be as soon as tomorrow, or tonight in the futures. The first resistance area is 3820, once that falls then a low may be in. If the market goes lower, it could go a little lower and bounce at 3700 support line or it could go way lower to 3400. The Fed meets on Wednesday and that might mean bears don't press and bulls don't pounce until later in the week. Having said that, the three black crows on the daily chart is indicative of exhaustion coming at the tail of a long down move.

Individually, many charts look ugly. Here's my favorite bank because it is loaded up with crypto risk:

New 52-week low for Facebook.

FedEx, an important, economically sensitive stock, put in a favorable candle for a bottom.

Who's up for a 2008 or 2020 style collapse before the Fed even seriously tightens? Imagine those crashes without any bailouts and you have some idea of what is coming. Or imagine if those bailouts caused oil to shoot to $200 per barrel and gasoline to $10 a gallon, and you have some idea of what could be coming if they try a bailout before consumer price inflation drops.

I watch boring, stable stocks that invest in things like commercial and residential real estate. BXMT is the commercial side. It plunged 7 percent today, a massive drop that speaks of an economic calamity.

High yield bond spreads are surging towards the point where financial markets give up the ghost and implode. I think it speaks to why the market will probably bottom out fairly soon even if it means a quick 10 percent plunge first. Things are getting out of whack so to speak, and my sense is the faster moving markets will bounce a bit while the economy deteriorates and sets up the next leg down. Otherwise, if markets are accurately signaling a depression, then stocks are headed below the March 2020 low fairly quickly and we'll be talking about my 1500 target on SPX before year-end.

I don't have a good read on public sentiment. The public is upset about gas and food prices, but it seems like the ruling class' Trump obsession, declaring guns and Trump voters the enemy, the Roe vs Wade decision etc., are all giving the media good excuses for not covering the economic devastation unfolding in the markets. One can only imagine the non-stop apocalyptic reporting if Trump had been re-elected and something similar was unfolding. To some extent, the media is beside the point, but psychology matters for markets and the media can massage it for long periods of time.

At some point, the public will realize the depth of the economic destruction, but not yet.  

Credit Risk Still Hasn't Joined the Party

It's moving up, but the plunge in high-yield debt has been mainly driven by interest rates thus far. I expect this will be yet another problem for the bulls soon enough. Investment grade credit has deteriorated faster than junk.

Support Bounces

Apple at 200-day. FDX, BTC. Many more, but some big ones. Anecdotally, fear peaked among the dumb money. My guess is most bulls sold out over the past few days, if not this morning. I doubt many bought today's dip, which was likely driven by short covering. Buying will come later, if at all, setting up the next mvoe lower. Nothing has been solved with respect to inflation or the Federal Reserve's policies. As with omicron, Russia is a distraction. The market is rallying today for technical reasons. Bulls will buy into bullshit narratives like this one: Is This a Crisis to Buy? Financial media will be out saying peak fear is the time to buy...not reminding people that Russia has zero do with this decline. The whole way down they will make up new narratives post hoc.

What have bonds done? Some have been pummeled, but there ZB sits right near its long-term support.

The bond market remains the main event. Things are taking more time to develop, but the inflation/deflation resolution is still an open question in my mind. Rate hike expectations did fall today, helping the Nasdaq lead.

The smart move for a bull was selling everything on December 31. Or convert their entire portfolio to commodities and related investments. The bear market is the slow process of bulls realizing they are in a losing position that is growing weaker over time.

Finally, bear markets destroy the financial sector. There hasn't been a real bear market since the 1970s. Stimulus has pumped money in every time. Technology made it easier to trade. A lot of people are trading and day-trading in the markets because its "the place to be." At the depths of the bear market, being a stock trader or day trader will be like telling someone you trade something like potting soil. The attention the markets receive, the amount of money trading every day, is itself a symptom of the credit bubble and bull market. A real bear market will grind most traders into dust. Bulls will give up years of gains.

For now, everyone still thinks this is some type of correction like has happened several times over the past decade. I believe a real bear market is underway, and that stocks are going to be making a new low next month. For myself, I closed out almost all my positions today. Which might be a contrarian signal! But most of my options are short-term and I don't want to sit through an extended rally. There are gaps above that will be prime spots for going short again.

Another View of LQD

My puts on LQD gained 60 percent today, but I don't buy puts for sub-100 percent gains. Multibaggers only. That's a great looking double-bottom on the inverted chart.

Here is LQD unadjusted for dividends. Looks more like a head-and-shoulders pattern (2020 spikedown aside) that targets to around the $110 level.