GETTING TECHNICAL

Bond Market Is Sending Big Warning to Investors

With rates falling despite the Fed’s desire to hike, bonds are signaling deeper problems in the market.

Cue the spooky music: The hairs on the back of the bond market’s neck are standing on end. Despite the fact that stocks are within striking distance of last year’s all-time highs, money continues to pour into bonds, suggesting that something is amiss.

The very essence of a trend in the markets is that rising prices create more demand. That, in turn, pushes prices still higher, increasing demand further and so on.

So when the stock market shows resilience almost every day as it bounces back from a weak open – including Monday on Brexit fears – and money flow is not positive, the cognitive dissonance is fierce. Making the dissonance worse, the market’s breadth is so strong that the NYSE advance-decline line is at generational highs.

Yet it is the bond market that continues to attract the cash.

Although not representative of the entire stock market, the money flowing into the SPDR S&P 500 Trust exchange-traded fund (ticker: SPY ), as represented by the on-balance volume technical study, has actually been declining since the middle of last year, albeit with about a one-third recovery during the 2016 market rally.

Compare that to the on-balance volume chart of the iShares 20+ Year Treasury Bond ETF ( TLT ), which has been straight up since last summer and on-fire since 2011 (see Chart 1).

Again, this one ETF does not represent the bond market, but it is one of the few places individual investors can express their concerns. Other bond market ETFs seem to be sending the same message, including the iShares iBoxx $ Investment Grade Corporate Bond ( LQD ), the iShares Core U.S. Aggregate Bond ETF ( AGG ) and the iShares S&P National AMT-Free Municipal Bond Fund ( MUB ). Each one of these ETFs now sport record high readings in their on-balance volume charts.

Even the bond-like iShares U.S. Preferred Stock ETF ( PFF ) shows money pouring in. The only bond market category with a falling on-balance indicator is the stock-like junk bond sector. The iShares iBoxx $ High Yield Corporate Bond ETF( HYG ) has a falling trend and only a modest recovery as it reacted to rising stock prices this year.

On-balance volume is just a technical indicator that follows trading action, or how investors are buying and selling existing shares of the ETF with the goal of discovering which side is more determined. Inflows of money into the fund themselves show that the universe of shares available for trading is growing indicating more investor interest. In fact, bond ETFs currently enjoy greater inflows than stock ETFs.

What this does to their prices is clear. The trend is up. And the trend in yields is down.

Charlie Bilello, Director of Research at Pension Partners, recently published a yield matrix of 14 Western and Japanese sovereign debt yield curves and in my view it is frightening. Nine counties now sport negative yields as far out as their 7-year maturities. Only three – the U.S, Spain, and Italy – offer yields above 1% at their benchmark 10-year maturity. Switzerland is negative out to the 20-year.

Whether it is a concerted effort by their central banks to go negative in the short-end of the curve or fearful investors piling into bonds at the longer end, the matrix shows something is very wrong out there.

I will leave further commentary to fundamental analysts and economists, but on the charts it is hard to look at most yield charts and see that the supposed absolute floor of zero percent has been broken. To me, this is akin to “breaking the buck” in money market funds when share values dip below the one dollar level.

The bond market action suggests market participants are just not happy right now, and they seem to be getting even less happy. Therefore, despite the good news coming from the stock market, all is not well.