Selling Quality for Junk is a Good Thing for Stocks

As the stock market started to pull out of the bottom made during the financial crisis one measure of risk taking, the ratio of US Treasuries ($TLT) to Junk Bond ($JNK) moved into a channel and started heading lower. The chart below shows the broad channel between the two bright red lines. This is a risk on measure, showing assets flowing from US Treasuries into high yield bonds. This continued throughout 2009 and into 2010. You can also see from the chart that the ratio is highly correlated to the S&P 500 ($SPY, blue area). It topped at the peak in 2010 and pulled back. It then surged higher again into 2011 and only to pullback into late 2011 and 2012. The latest move higher off of the double bottom began in May 2012 and continues today. The ratio becomes interesting in the short run as it is at a critical retracement of the move lower, at 61.8% of that range. To a technical trader breaking this Golden Ratio level can mean a continued move to the top of the channel with increasing confidence. Not a guarantee, but as if a speed bump or barrier has been removed. The other indicators that a technician might follow measuring momentum support a continued move up in the ratio and the ratio itself shows that it has room to move higher over this level without resistance from prior history without another test for a while. The green triangles show a Harmonic Bat (now we are deep into the technicals) formation that targets a move much higher to give an estimate of just how far it could go.


A continued flow from US Treasuries into high yield bonds does not guarantee a move higher in stock prices. But it adds to the broad context of measures that support more upward price action in equities.


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