Conclusion, Investment Implications, Strategy

Recent widening in high yield corporate bond spreads suggests that the November US stock market advance is stalling, but until investor assets begin to contract in key ETFs like the SPDR S&P 500 (SPY) it is too early to assume that an overdue corrective decline is underway.

Analysis and Rationale

In our March 9th report, entitled US Stocks At A Near Term Inflection Point, we pointed out that the BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread was testing its 21-day moving average from below and said that any further widening in the spread would indicate a trend of monthly (our tactical time frame) widening that has historically coincided with or closely preceded US stock market declines. Widening in this spread indicates an increase in credit risk for these bonds, which is an indication that the forward-looking and prescient bond market sees some trouble ahead.

The upper panel of Chart 1 below shows that the spread has indeed continued to widen, finishing yesterday’s (March 15th) session at 402 basis points, well above its 21 day moving average at 379.

Chart 1

The lower panel of the chart shows that the S&P 500 (SPX) has coincidentally declined by 2% between March 1st and 9th before rebounding sharply yesterday on the news that the Federal Reserve raised interest rates by 25 basis points for the second time in three months.

The question is: Is this the start of the corrective decline the market is due for?

The answer: Maybe, but a decline will not get going in earnest until investor assets flows turn negative.

The lower panel of Chart 2 below plots the total net assets invested in the SPDR S&P 500 ETF (SPY) daily since December, with a corresponding chart of SPX in the upper panel. The chart shows that, once the total net assets invested in SPY exceeded the $228 billion threshold, which was being negotiated since mid-December, SPX started its next (and current) leg higher. Investor assets are the fuel that drives a price trend, and indicate near-term conviction.

Chart 2

Until these assets start to steadily decline, below their 21-day moving average to indicate a trend of monthly contraction, it is too soon to assume that a corrective US broad market decline is underway.