The Bond Market Is Telling Us Something Important

1.) BONDS – Most people don’t spend much time thinking about the bond market. But if you own stocks, there are a few things happening in the bond market that you should absolutely be paying attention to. Primarily, "credit spreads." It’s really not complicated. Imagine two people ask to borrow $100 from you. The first is the U.S. government. Whatever you think about politicians, the government has historically been considered one of the safest borrowers in the world. The second is a company with a bunch of debt and a questionable financial situation. Who are you going to charge more interest? The risky company, of course. That extra interest investors demand for taking the additional risk is basically what we’re talking about when we talk about credit spreads. Watching what happens to that difference tells us a lot about what investors are doing with their money. During healthy markets, investors are willing to take risks. They’re buying stocks. They’re buying lower-quality bonds. They’re looking for opportunities to make money instead of places to hide it. Because investors aren’t particularly worried about these companies failing, they don’t demand nearly as much extra interest to lend them money. So the difference between what safe U.S. Treasury bonds pay and what riskier high-yield bonds pay gets smaller. That’s a tightening of credit spreads. When investors start getting scared, the exact opposite happens. Those spreads widen. So when credit spreads start widening aggressively...time to pay attention. That’s the bond market telling us something’s wrong. And right now, they’re not scared. Credit spreads are making new lows.

2.) US DOLLAR – The dollar has historically acted as a safe haven during periods of market stress. When investors get scared, money tends to move toward the dollar. Rising dollar = rising demand. When investors are feeling good and taking more risks, there isn’t as much demand for that safety. So, the read-through for understanding when risks are rising underneath the surface of price is to piece together both credit spreads and the Dollar. A strong dollar and widening credit spreads can be a dangerous combination. A weaker dollar and tightening credit spreads? That’s much more consistent with a healthy environment for stocks. Recently, those two elements didn’t agree. The Dollar was rising while credit spreads were tightening. But even during that phase, the Dollar was in a bearish (downward bias) trend. That downward bias in the Dollar has been in place now since the beginning of the month. I’ve written about it. So, I wasn’t concerned while credit spreads were tightening and the Dollar was having a bit of a counter-trend move up. The Dollar was still in a bearish trend and is continuing to roll over. This, along with the tightening of credit spreads, is what we want in a healthy market. Market analysis is a function of looking at everything…stocks, bonds, currencies, commodities, rates, foreign markets…everything. And right now, these are acting fine. What do I need to see to have real concern for markets? Widening credit spreads, risky bonds selling off, Treasury bonds rallying, and the US Dollar moving significantly higher. None of that is happening today. Today, the US Dollar and the bond market are telling us investors are still willing to take risks, and the stock market is telling us the same thing.

3.) SOUTH KOREA – South Korea is often regarded as the world economy's early-warning system. This is one reason we watch the KOSPI, or South Korea’s stock market. What are we seeing right now? South Korea’s exports confirm that demand is holding up. This is the artificial-intelligence boom ceasing to be a story about valuations and becoming one about real demand. Like it or not, AI is likely here to stay.