How To Time The Bottom of This On-going Market Correction?
Equity markets are witnessing a carnage of sorts and the primary worry in the mind of every investor right now is to what extent equity markets can fall further!
But instead of speculating if we’re going to get another 5% or 10% or even a 30% drop from here, I believe investors should focus their energies to understand what indicators to look at, which can reliably signal how long this correction will potentially last, and when markets will potentially bottom!
And if you are looking for such indicators, then turn your glance towards the bond market!
After all, as the old saying goes – Stocks are for rookies, bonds are for the Big Boys!
And the bond market indicator, which I think is going to come in most handy at this stage with respect to navigating the equity markets is something called “Junk bond spreads"
"Junk bond spread" essentially represents the additional interest rate (also called spread) demanded by bond investors from mid and small caps companies to invest in their bonds over and above the risk free rate (which is the rate paid by US government on US government bonds).
This additional interest rate (or spread) is meant to compensate bond investors for the higher risk of default that is incident while investing in bonds of mid and small caps companies.
A high spread means liquidity is drying up for small companies and that they are finding it difficult to raise money. And rising junk bond spreads have historically been a very reliable leading indicator of an upcoming recession.
This spread is currently at 4.45 and is rising fast! Clearly, that’s NOT a good sign. If it continues to rise and goes above 5 to 5.5, then that's something to be worried about, and if it goes above 6 to 6.5, that would be a danger sign, and would very likely mean that the US economy is indeed headed into a recession, and that equity markets are likely in for a more substantially crash.
However if and when junk bond spread starts to trend downwards, then that would be sign that the bond market is sensing a resolution to the trade war situation! That would be the time to take fresh positions in stocks!
But until junk bond spreads do NOT start trending downwards decisively, it's better to stay away from equity markets, which is what we are doing right now across our client portfolios.
But we remain ready to pivot as soon as we see signs of a decisive downtrend in junk bond spreads!
This is time to be very very data dependent... there’s simply no room for gut feel investing at this stage!
You can track it at https://fred.stlouisfed.org/series/BAMLH0A0HYM2
