Liquidity in the markets, i.e. how much funds are available in the market, is an important gauge for when stocks and other risk assets may go up, or down.
Higher liquidity is usually bullish while less liquidity is more bearish.
One of the proxies we can use for a quick gauge of market liquidity (expanding vs. contracting) is to look at a relative comparison in the bond market of High Yield Corporate Bonds (HYG) vs the 3-7 Year Treasury Bond (IEI).
As economic conditions improve and liquidity expands (credit spreads tightening), the HYG vs IEI chart will rise.
Conversely, as credit/liquidity begins to tighten (credit spreads widening), the chart will fall. The broader market, and the banking/financial sector in particular, will tend to positively correlate.
Daily Chart Comparisons:
High Yield Corporate Bond (HYG) vs Treasury Bond 3-7 yr (IEI), S&P Bank ETF (KBE), Financial Sector (XLF), S&P 500 (SPY)
High Yield Corporate Bond (HYG) vs. Treasury Bond 3-7 yr (IEI) – Weekly Chart
The Banking industry, Financial Sector, and S&P 500 exhibited strength in early August 2024 and through the month end.
Then, the HYG/IEI ratio started turning down again in late August/early September and signaled liquidity/credit concerns rising.
As you can see in that first chart, the S&P Bank ETF, Financial Sector (XLF), and Broader S&P 500 (SPY) reacted and ALL started correlating and headed downward as well.
We want to take advantage of these changing market conditions and like Bank of America (BAC) for a shorter term, bearish-to-neutral to slightly-up “structured trade” idea:
Selling to open a November 14th 2024 (Monthly) 40/45 “Bear Call’ Credit Spread for approximately $1.10 per contract.
- We will take profits (buy to close) when our credit shrinks by 50% (profit)
- We will exit (buy to close) when our credit widens to $2.20 (stop loss)
- We want to be in this trade for approximately 14 trading days and do not want to hold over earnings, which are scheduled to be released on 10/15/24.
We found this trade setup using – what else? – our Market Rover software… which simplifies trend following in any market.
Serge & John
