2 Charts pointing to ‘Calm in the Markets’ – Part 1

The High Yield Bond market is having issues, bid: ask spreads have widened, liquidity is relatively lower, a few small Bond Funds are closing doors due to redemptions etc. The equity market (S&P500) is almost flat for the year, 15 days’ shy for the end of 2015. The Fed is meeting this week which will likely result in a 25bps rate hike. The media is doing what it does best, sell newsprint or the digital equivalent of it, with some calling this a bigger event then oil / Lehman Brothers collapse.

We say ‘nay-nay’ to those prognosticators. 

The chart below (Fig. 1) gets us to a different conclusion. Money supply or liquidity at the Banks is adequate to say the least, they are sitting on $2.5+ Trillion of excess reserves (orange coded line), so the Fed raising rates by some basis points is not going to tighten systemic liquidity. Secondly, 10 Year U.S Treasuries are not seeing any flight to safety driven off Junk bond market issues and are trading in a relatively tight band (red coded line) as before. Money velocity of M2 (blue coded line) while it remains singularly depressed since the 2008 recession, has not seen a further sharp decline in its trajectory. These combined metrics do not signal any broad equity market weakness to us.

Fig.1

Specific sectors in the High Yield space are going have a rough time for sure, namely Energy and Materials. In fact, High Yield bonds have performed similar to Small Cap stocks this year (Fig. 2), which when you seek causation as one sees correlation, makes intuitive sense because Junk bond issuing companies tend to be smaller lower credit quality ones, hence the correlation is reasonable.

Fig.2

This points to a shakeout in the two sectors where the fittest will survive and others will seek consolidation or bankruptcy protection but will have limited impact to the broader market. This also ties in to our prior commentary and opinion where our expectation of Mega Cap stocks leading the market has been seen while small caps underperform. We expect it to continue for the remainder of 2015.