Where We Are in a Risk On, Risk Off World

• Posted by Greg Harmon
• on February 28th, 2013

The risk on, risk off, market has been in full swing recently with the SPY traveling more in the last 6 days than the rest of the year prior to that. Many look at this increased volatility as a sign of a top with a wicked correction about to come. Others just as working back to a more normal volatility range with an overshoot in the process. When things are not so clear it make sense to pullback to a longer time frame to get better clarity. And when looking for clarity in a risk on, risk off world why not try the bond market proxy, the ratio of US Treasuries to High Yield Bonds.

The Technicals

The chart above takes a look at this on a weekly timeframe using the iShares 20 Year Treasury ETF, $TLT, against the SPDR High Yield ETF, $JNK. The portion of the chart of interest is from the center of the Fibonacci Arcs to the right. Prior to that is the massive reallocation back into risk after the financial crisis bottom. After the ratio retested the 38.2% retracement it pulled back to the 2.90 area and then bounced back to 3.54. A second failure to break higher formed a Double Top and it is now settled back at the 2.90 ratio and building a bear flag. The Measured Move lower takes it to 2.44, just above a full retracement back to the 2011 low at 2.35. The Relative Strength Index (RSI) is also in bearish territory and the signal line from the Moving Average Convergence Divergence indicator (MACD) is falling. Add in that the ratio is below all of the Simple Moving Averages (SMA) and the Bollinger bands are opening lower and you have the Technical Analysis equivalent of the stars aligning for a move lower. All that is needed is the catalyst. There seem to be a lot to choose from lately, with the next potential being the Non-Farm payroll report Friday.

The Meaning

What does this mean in real world terms? There was a big money flow into risk assets from risk free assets late 2008 until early 2011. As the stock market was bottoming during the financial crisis the shift began. Since then a short rebound, almost correcting an over adjustment, and stagnation. A balance between risky and risk free assets that has held for 2 years. A break lower on the ratio, would indicate another leg of funds moving from risk free assets to risky assets. Be it high yield bonds or equities, a break lower in this ratio is very bullish for the stock market and risky assets everywhere. One final point. The Federal Reserve has not been very good at disguising that this is their goal. And they are throwing a lot of money at it. Do you want to bet against them?

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Dragonfly Capital Views Performance Through February 2013 Expiry

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