March 14, 2018
The world was convinced that inflation was imminent, that bond yields were rising, and thus that investors ought to dump anything bond related. The 10-year T-Note was assuredly headed north of 3%, people were going to stop taking out mortgages, companies were going to stop investing, and inflation was going to be the “new normal”.
But wait! That sentiment appears to have been overdone, and bond prices got oversold. We can measure the oversold condition of T-Bond prices in a large variety of ways, but this week’s chart looks at a different set of data to get a unique insight.
FINRA publishes Advance-Decline data on corporate bonds every day at this site. They break it down into “Investment Grade”, “High Yield”, and “Convertible”.
The High Yield A-D data have great interest for me in terms of the messages they can give for the stock market. See this prior Chart In Focus article. And the Investment Grade A-D data have importance for what lies ahead for T-Bond prices.
This week’s chart looks at a Ratio-Adjusted Summation Index (RASI) for the Investment Grade bond A-D data. The qualifier of it being a “Ratio-Adjusted” Summation Index means that a mathematical adjustment has been made to factor out changes in the numbers of issues traded. See this link for an elaboration on the math, if you are interested. The short version of the description is that this process makes long term comparisons more meaningful.
The Summation Index measures the acceleration which takes place in the A-D statistics. This can convey several messages, depending on the context. The message right now is that the high grade area of the bond market has gotten extremely oversold, and thus at least a bounce is due right now. Plus, a larger up move is in the script for later.
The FINRA bond A-D data only go back as far as 2005. We wish we had perfect data farther back. Barron’s used to carry A-D data on “corporate bonds” (without elaboration), which we have kept for those many years. Here is a lookback at that data:
The numbers of issues back then were much smaller, but we can still see the relationship to T-Bond prices. It is not perfect, of course, and it missed a lot of the turns which came in T-Bond prices.
The more current data seem to be better and more useful. And the application of the math of the McClellan Summation Index makes it even more useful.
We just saw a very low reading in the high grade bonds RASI, nearly the equal of the low seen in 2013. This is a message that the corporate bond market has become very oversold. But it is not an unequivocal message about what comes next.
Sometimes a very low RASI reading like this marks an exhaustive bottom for T-Bond prices. But other times there needs to be another price dip before the final low is in, and prices are free to trend upward. Given the small sample size of instances since the data begin in 2005, I have not figured out a way to tell the difference between the two types of outcomes. So for now, while we see the big fat oversold reading on the RASI, I cannot prove yet that a retest of the price low is off the table.
The takeaway point is that even if there is a retest of the price low, we still can expect higher T-Bond and high grade corporate bond prices in the weeks and months ahead. And that will frustrate the legions of analysts expecting higher inflation and higher interest rates.