“Disconfirmation bias: When a person believes something so strongly they have difficulty accepting any evidence to the contrary.”
When stock indices around the world print new highs, we often see extremist articles and analysis appear which explain why these new highs are not justified. This isn’t new, “permabears” exist and they love to speak (quite loudly) when price forms a new high. With that being said, we do not want to write off evidence for the bear case, instead I find it productive to keep eye on such counter arguments and become familiar with areas of the market that do not confirm the recent move to all-time highs. Below are a few charts which either support the bear case, or are yet to confirm the new highs we saw from US equities.
High Yield Corporate Bonds (HYG) vs. Treasury Bonds (IEF)
Although High Yield Bonds have outperformed 7-10 Year Treasury Bonds by 3.29% year-to-date, the ratio is yet to break above a diagonal trend line emphasizing the current 1+ year downtrend. Do we need High yield to be outperforming Treasury Bonds for stock prices to continue to move higher? No. But it would be viewed as constructive evidence that the bull market in stocks is just heating up.
Australian Dollar vs. Japanese Yen (AUDJPY)
The highlighted portions of the above chart represent instances of price divergence between the S&P 500 index and the AUD vs. JPY currency pair. These divergences last anywhere between 2 and 4 years, but historically resolve themselves in the currency pair’s favor. If you consider AUD vs. JPY a leading indicator of US equities, the current downtrend does not support the bull case for stocks.
Consumer Discretionary vs. Consumer Staples
Much like the High Yield vs. 7-10 year Treasury Bonds, CD vs. CS is yet to move above a diagonal downtrend line that highlights the current sideways movement of the ratio. As mentioned in previous posts, this is often used as a “risk on / risk off” gauge of the US equity market. When consumer discretionary is outperforming consumer staples, it signals a risk seeking marketplace. A move above the downtrend line would be viewed as bullish and spark additional confidence that investors are becoming less risk averse.
S&P 500 vs. Gold
In this chart, the S&P 500 appears to be diverging from the Stocks vs. Gold ratio. Similar to HYG vs. IEF and XLY vs. XLP - if a move above the recent downtrend line were to occur, it would be viewed as constructive and a positive sign for stocks in general.
There are plenty more charts I’d be able to cook up and attempt to explain why they are not extremely positive for US Stocks, but we must remember that Price is King. With stocks all over the world (Euro-zone and US specifically) making new highs we can’t ignore what the market is telling us.
That’s enough out of me. Have a great Thanksgiving, see you in December.