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Chart In Focus

Bond Funds Now Say Liquidity Restored

Chart In Focus
April 25, 2013

Three weeks ago, I wrote about the indication of a liquidity problem which was being given by closed end bond funds.  Those are among the most liquidity-sensitive issues, and so when they are doing something different from the major market averages, it is a sign of potential liquidity problems which could come around and bite the rest of the market.

We did see the fulfillment of that prophecy with a halfway decent selloff for the major averages in mid-April.  But now the message from high-yield bonds and closed end bond funds is that liquidity has been restored, at least for the moment.  While the SP500 has made a pattern of lower lows and (thus far) lower highs, high-yield bond funds are defying that pattern and showing strength.

There is no perfect market index which captures the behavior of the high-yield bond universe.  I like to use HIO as a good proxy for that whole segment of the market.  It does a pretty good job of showing weakness ahead of liquidity problems which can bite into the overall market, and it also shows strength ahead of big rebounds in the SP500.  Right now, it is showing a pattern of higher lows and higher highs, and looking much stronger than the stock market. 

The chart I showed here 3 weeks ago was an A-D Line of closed end bond funds which are traded like stocks on the NYSE.  They are also quite liquidity sensitive, and so in the very rare instance when this A-D Line makes a lower high while prices make a higher high, it is rightly seen as a problematic message for the overall market.

That message of trouble for the market has now been resolved by seeing this A-D Line surge ahead to a higher high:

Bond CEF A-D Line

Whereas it was showing trouble for the market a month ago, now it is conveying a big "Never mind".  The higher high says that the previous liquidity problems have been resolved, at least for the moment.  This is a message which can change back again at any time, but for now the weaklings who are very liquidity-sensitive say that liquidity has been restored. 


Tom McClellan
Editor, The McClellan Market Report

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