Thursday, January 15, 2009

Observing Market Sentiment Through the Lens of Credit Markets

The financial crisis continues, as banking stocks moved today to new bear market lows ($BKX; top chart). In the wake of zero interest rate policy, however, the search for yield has kept municipal bonds buoyant (TFI; second chart). We also saw nice runups among preferred stocks (PFF; third chart) and high yield corporate bonds (JNK; bottom chart), but both have pulled back as financial issues have retreated.

I recently stressed the importance of catching market themes that reflect the sentiment of dominant market players. The fixed income markets offer a nice view of investor flight to safety (Treasury bond price strength) vs. willingness to assume risk in search of yield. Recent action suggests that, in the face of uncertainty in the financial system, investors will reward safer sources of yield relative to riskier ones. Observing how these segments of the credit markets are trading during the day provides a worthwhile view on trends and turnarounds in investor sentiment.