Friday, April 23, 2010

ETF Pairs as Sentiment Gauges: HYG and LQD

In recent posts, I have focused on several ETF pairs as sentiment gauges for the broad stock market. Those include:

Above, we see a different ETF pair that tracks the relative performance of high yield credit (HYG) vs. investment grade credit (LQD). The idea is that, when investors expect stable and positive economic conditions, they will display their risk appetite by pursuing higher yield. When investors expect unstable and poor economic conditions, they will tend to be risk averse and seek the relative safety of high quality credit over high yielding issues.

As the chart above illustrates, throughout the bull market, we've seen high yield debt outperform investment grade issues. While the pace of that outperformance has waned recently--we have not made fresh 2010 highs since January--we've not seen any underperformance of HYG that would lead us to worry about an increase in perceived default risk.