In my recent articles, I’ve talked a lot about the credit cycle, and how important it is to the economy. But did you know it can also give you important “buy” and “sell” signals for stocks?
Take a look at this chart below, it shows the difference in yield, or “spread,” between mid-grade corporate bonds, and 10-year U.S. Treasuries. When investors are greedy and bullish, they’ll pile into riskier bonds rather than Treasuries, causing this spread to narrow.
When they’re fearful and bearish, they’ll dump riskier bonds and buy Treasuries instead, causing this spread to widen.
You can also see in the chart, that since the late 1990’s, we’ve had several inflection/turning points. And in late 1999 and early 2000, spreads “broke out to the upside” (marked by a red oval). That helped point to a recession and market downturn – a great “sell” signal for stocks
Then in late 2002/early 2003, spreads put in a “blow off” high, and began to turn lower (marked by a green oval). That was the bond market’s way of signaling, that the end of the bear market and recession was finally there – a great “buy” signal for stocks.
In the second chart below, it shows the Dow Jones Industrial Average on a monthly basis.
You can see a red oval that corresponds to the spread-based “sell” signal, as well as a green oval that corresponds to the spread-based “buy” signal. They worked pretty well, didn’t they?
You can see a similar pattern in 2007-2009, when the credit market sent out crystal clear “sell” and “buy” signals. If you had only sold and bought the Dow on those signals, you would have profited generously.
This past summer I received a “sell” signal from the bond market, and it was a key factor behind my decision to pare back stock exposure dramatically in my trading and investment services at that time. I made a decision to buy more aggressively “short” vulnerable stocks, something that I have not done in several years.
So far that strategy is panning out, and I plan to stick with it until my credit cycle indicators improve (and by the way that has not yet happened).
If you are interested in more credit cycle analysis and want to know how you can trade your way through the bearish and bullish phases of the credit cycle, then be sure to give my comprehensive course on interest rate trends and cycles a try. To watch the first session of my course, “How To Profit From Rising Interest Rates” click here!
Until next time,
Mike Larson is a Senior Analyst for Weiss Research, and is also the editor of Safe Money Report and Interest Rate Speculator at Weiss. A graduate of Boston University, Mike Larson formerly worked at Bankrate.com and Bloomberg News, and is regularly featured on CNBC, CNN, Fox Business News and Bloomberg Television as well as many national radio programs. Due to the astonishing accuracy of his forecasts and warnings, Mike Larson is often quoted by the Washington Post, Chicago Tribune, Associated Press, Reuters, CNNMoney and many others.