"A bird doesn't sing because it has an answer, it sings because it has a song." - Lou Holtz
In the article titled "Junk Bonds Sing the Siren Song" published here on Seeking Alpha May 11th, I compared two of the "riskiest" segments of the bond and stock market to each other and made the argument at the time that an important resistance levels was being reached in the relationship of Junk Debt to Small-Cap stocks. I had been arguing since early April that a "mini-correction" was likely for stocks, and used that price ratio as another reason for why the decline could be shallow and short lived.
Below is an updated version of that chart. Take a look below at the price ratio of the SPDR Barclays High Yield Bond ETF (JNK) relative to the Russell 2000 ETF (IWM). As a reminder, a rising price ratio means the numerator/JNK is outperforming (up more/down less) the denominator/IWM. A falling ratio means the opposite.
(click to enlarge)
I've annotated the chart to show how well the ratio has trended in the past three years. Within the "risk" segment, Junk Debt performed better than Small-Cap stocks during the post-Flash Crash period of 2010, Summer Crash of 2011, and "mini-correction" of 2012. Notice that the ratio on the far right of the chart appears to be having a hard time breaking through resistance. Because of the inability of Junk Debt to outperform past this level, a potential downtrend may emerge favoring Small-Cap stocks.
The implication? The pendulum may be starting to swing away from favoring risk in debt to risk in equities. This would be consistent with the reflation theme I have continued to stress in my various writings since the start of 2012. A bit more time is needed to confirm, but given stock resilience it seems plausible to believe that money will get comfortable in equities again very shortly.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing.
