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Credit Giving Equities A Red Flag

Tyler Durden's picture




 

Submitted by Erico Matias Tavares of Sinclair & Co.

Credit Giving Equities a Red Flag

With US equity markets trading in the vicinity of all-time highs, by definition you could have purchased the major indices at any point since the bottom in March 2009 and you would be in the money.

Extrapolating this strength into the future, longer term investors (those with a holding period measured in months) might be tempted to continue buying at these levels. Is this a wise strategy right now?

Nobody has a crystal ball so we are dealing with probabilities here. Looking at other asset classes can provide some clues of where we are in the current market cycle – in other words, establishing a near-term bullish or bearish bias, hoping to improve these probabilities in our favor.

The S&P/LSTA Leveraged Loan 100 Index mirrors the market-value-weighted performance of the 100 largest institutional leveraged loans based upon actual market weightings, spreads and interest payments. These are loans provided to companies that already have considerable amounts of debt in their balance sheets, therefore carrying a higher risk of default.

This index can thus provide a good sense of both liquidity and risk appetite in the credit markets. If lenders are feeling sanguine about the prospects of the economy, they will extend more leveraged loans at amenable rates. Borrowers in turn will use these funds to buy other companies, build out their businesses and/or pay back their shareholders. If the index is going higher it is “risk on” in the markets, which should be constructive for equities.

Weekly S&P500 Index (LHS) and S&P/LSTA Leveraged Loan 100 Index (RHS): Sep 09 – Jan 15
Source: S&P, The Loan Syndications and Trading Association.

And we can see this relationship at work in the graph above. The leveraged loans index has for the most part been a leading indicator for equities since the start of this bull run (it even bottomed in late 2008, a few weeks beforehand). The yellow shaded areas represent equity retracements greater than 8% from the prior high. Leveraged loans typically resume the uptrend quicker or have shallow corrections, providing in each case a bullish signal for equities.

Let’s focus on what happened in the lead up to the summer of 2011, right before the markets cratered on the back of everything that was going on in Europe and the downgrade of the US' credit rating by S&P. The leveraged loans index peaked at the start of the year and traded sideways up until that eventful August. This was a sign that something was not right in the credit markets; and equities pretty much followed the same pattern.

If we fast forward to today, we can see that the leveraged loans index peaked in July 2014, indicated by the red line in the graph, and has noticeably declined since; at the same time equities continued to move higher, a divergence which is a novelty in this bull market. Is this telling us something?

We believe so - it is a red flag for equities.

OK, loans are loans, equities are equities. After all, with no juicy yields available in other asset classes, equities are the only game in town right? And we do not have a large enough dataset to have a high degree of statistical confidence in this relationship, as the leveraged loans index is only available from early 2008. So it is possible that equities may continue moving higher from here.

But let’s also look at the breadth of the equities market, which can be used to confirm the strength of recent moves. More stocks advancing in relation to those declining is a bullish sign; meaning, there is a broad participation of stocks, a sign of liquidity and healthy investor appetite. The reverse also applies to spot areas of weakness, particularly when equities move higher without the confirmation of breadth.

The advance-decline ("AD") line is generally used as a measure of market breadth. It is calculated by accumulating the differences between advancing and declining issues over time [Note: we use the weekly closings of all stocks in the S&P500 and the NASDAQ to calculate the AD line, thus providing a broader representation.]

Weekly S&P500 Index (LHS) and the Advance-Decline Line (RHS): Sep 09 – Jan 15
Source: Wall Street Journal.

Notice in the graph how the AD line just jumped out of the gate much stronger than the equity index at the end of the bear market. This was a very bullish signal. And it has pretty much remained a leader - until recently.

Here’s one thing that is really intriguing: the AD line peaked a week before the leveraged loans index back in July (again, shown by the red line). Not long after, we witnessed the greatest pullback in equities for many months. The market’s advance since then has been supported by a smaller number of stocks, which is not indicative of strength.

Therefore, we have the leveraged loans index and the AD line basically telling us the same thing.

What does this all mean? Again, we are dealing with probabilities, but these divergences suggest caution for equity investors. If you are in the market it may be a good time to tighten your stops; otherwise you may wish to wait for everything to be in sync before jumping in.

After all, you do not want to be going up the equities creek without a good credit paddle.

 

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Sun, 01/11/2015 - 11:46 | 5648234 LawsofPhysics
LawsofPhysics's picture

Technical analysis in in fully manipulated "market".  Good luck with that.

Sun, 01/11/2015 - 11:55 | 5648252 Looney
Looney's picture

... After all, you do not want to be going up the equities creek without a good credit paddle.

The equities creek has been poisoned by the nanny Fed. I wouldn’t take a diarrhea-dump in that creek ;-)

Bon appetit! ;-)

Looney

Sun, 01/11/2015 - 12:18 | 5648302 Headbanger
Headbanger's picture

The Feral Reserve is tapped out you mooks!

So they can't stop the inevitable market implosion they only made worse propping it.

Another sign of the deflationary implosion ahead: (scroll down to see CRB imploding and Dollar exploding)

http://stockcharts.com/public/1890263/tenpp/2

Sun, 01/11/2015 - 12:25 | 5648331 stant
stant's picture

The events in France Gona light the second stage booster on the dalla. And the joos are heading to zion

Sun, 01/11/2015 - 12:26 | 5648335 LawsofPhysics
LawsofPhysics's picture

"Tapped out" -- bullshit.  The primary dealers can access all the money they want at near zero interest!!

Plenty of printing going on.  for now, thanks to the REPO and reverse REPO action it simply remains "sterilized".

We are still being set up to be sold a new world fiat.  Keep aquiring physical assets. period.

Sun, 01/11/2015 - 12:32 | 5648348 Headbanger
Headbanger's picture

Bullshit bullshit!

And NFW will the US Gubmint and Feral Reserve allow any new world fiat to replace the Almighty Dollah

Sun, 01/11/2015 - 12:40 | 5648372 LawsofPhysics
LawsofPhysics's picture

I guaranty that anyone on this site would have no trouble becoming a very profitable limited liability company if they had access to even a few billion at 0.01% interest.

Sun, 01/11/2015 - 13:22 | 5648492 El Vaquero
El Vaquero's picture

The Fed still has the printing press and the government is running out of lenders. 

Sun, 01/11/2015 - 13:00 | 5648433 DeadFred
DeadFred's picture

Your chart only takes in the USD 120 top. Don't assume we won't visit the 160 top before it.

Sun, 01/11/2015 - 11:53 | 5648254 Aeternus
Aeternus's picture

Oh, so now it's time to go short huh? Fuck, i've been getting my ass burned for six fuckin' years now.

https://www.youtube.com/watch?v=zn-Cab0XRlw&list=UUOGz5pLBw6Yrkgk3gPL13ug

Sun, 01/11/2015 - 12:50 | 5648397 HardlyZero
HardlyZero's picture

This time last year I was thinking the markets would go down.

It took a year to see the market level off (Triple top now since December 1, 2014 ?)

Got my shorts on (again)...yes it has been a painful 2014.

Sun, 01/11/2015 - 13:03 | 5648442 DeadFred
DeadFred's picture

And painful 2013, 2012 and 2011 before it. Yet some of us won't learn and the shorts are on again.

Sun, 01/11/2015 - 13:28 | 5648514 El Vaquero
El Vaquero's picture

It's time to stay the fuck out of the market.  1) You (likely) aren't an insider which means you are likely missing key information on timing it and 2) When this shit does finally implode, you are going to be standing there in disbelief after having watched it levitate on paper bullshit for so many years. 

 

That being said, events are pointing to a bond crisis sometime this year unless oil prices go back up.  Tomorrow?  Sometime in December?  Who knows.  I'm not an insider either.  I just know that this shit cannot go on forever, and gloomily await the presses being kicked on and shifted into overdrive.

Sun, 01/11/2015 - 12:04 | 5648281 ArkansasAngie
ArkansasAngie's picture

We you can indeed predict that the manipulators will manipulate to their best advantage.  The only issue is when and how they get knocked out of that saddle.  Does the dad gum horse have to keel over dead?

Sun, 01/11/2015 - 12:02 | 5648276 ebworthen
ebworthen's picture

Take away the FED and Treasury backstopping Wall Street with the Public Treasury at the expense of citizens and "technical analysis" might have some meaning beyond whistling past the graveyard.

Sun, 01/11/2015 - 12:02 | 5648277 Captain Willard
Captain Willard's picture

I assume some of the weakness in leveraged loans is driven by the weakness in the oil markets. I wonder if the non energy_related loan market has weakened much. I doubt it. In any case, this analysis is somewhat incomplete, though it clearly bears watching. For sure these problems can spread and have done so in the past.

Sun, 01/11/2015 - 12:06 | 5648284 q99x2
q99x2's picture

But at the end of 2011 is when the FED implimented its market software applications and took over stock markets precisely because of this problem.

Sun, 01/11/2015 - 12:13 | 5648306 NoWayJose
NoWayJose's picture

Well since 2011 the US has added 4 trillion in debt - yet Treasury yields are down?? That will show those US credit downgraders. They should bump the US back to its full AAA rating. The Fed has shown that it will buy evey bond if it has to - that should make them totally safe!

Sun, 01/11/2015 - 12:15 | 5648311 Bossman1967
Bossman1967's picture

Its a fools market. Your a fool to be in and a fool not to be. For me Ive been the PM fool and a bath I have taken but if 1plus 1really equals 2 to my stack in the end will be worth much much more than money.

Sun, 01/11/2015 - 15:09 | 5648748 Pool Shark
Pool Shark's picture

 

 

With regards to the stock 'market': It's not a gain until you sell.

With regards to Precious metals: It's not a loss until you sell.

Are you accumulating PM's? If so; just have patience...

 

Sun, 01/11/2015 - 12:31 | 5648343 NeedleDickTheBu...
NeedleDickTheBugFucker's picture

Recognizing that credit investors are "smarter" than equity investors should not be an epiphany.

 

Sun, 01/11/2015 - 12:34 | 5648351 HardlyZero
HardlyZero's picture

Since December 1, 2014 thrugh Friday, has the Dow and S&P had a triple top ?  or head and shoulders ?

Hmmm.

Sun, 01/11/2015 - 12:37 | 5648361 agent default
agent default's picture

Don't worry the Fed is on it.  Get it through your heads, the central banks have rendered market signals and any sort of feedback mechanism totally inactive. 

Sun, 01/11/2015 - 12:38 | 5648366 Conax
Conax's picture

Buy low, sell high.

Sell equities.  Buy silver.

there ya go.

Sun, 01/11/2015 - 14:23 | 5648631 buzzsaw99
buzzsaw99's picture

quaint. it was barzini all along [/don corleone]

Sun, 01/11/2015 - 15:21 | 5648784 K_BX
K_BX's picture

I see into the future - FED buying EVERYTHING! So BTFD, before everything is sold out. Don´t wanna go into debt? FED will stuff it down your throat if they have to - keep the credit cycle going into infinity, deleveraging is forbidden.

 

Sun, 01/11/2015 - 16:46 | 5649050 venturen
venturen's picture

I am Long with a Soylent deverivates backstop...IT IS ALL GREEN! The take over of monteray system is complete...and Democrats aren't happy till you have been Detroit. They will never willing give up free stuff...that really just goes to the richest!

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