Why These Two Indicators Are Important
In addition to the positive fundamental backdrop
developing in the US economy, two leading market indicators continue to paint a positive
picture for the US stock market.
Industrial Metals
The Journal of Commodities Industrial metals index (which is comprised of
copper, nickel, zinc, aluminum and lead) continues to perform well. In fact,
today it closed at a three-year high. The reason why this bodes well for
equities is that industrial metals are an integral component in the majority of
durable goods. And, demand for durable goods typically increases alongside
corporate profits, which makes sense since companies usually invest in new
equipment to manufacture additional goods to meet increasing demand. As can be
seen in the chart below, there is a strong correlation between the JOC index and
forward earnings.
Junk Bonds
The spread between junk bonds and US Treasuries is still well within its
narrowing trend that began last October. This
spread — difference — between the yields on junk bonds and those of US
Treasuries with similar maturities, is basically the risk premium that
the investors assign to these issues. And, it can be used
to gauge the overall state of the economy and therefore corporate health.
The reason why this is a useful tool for equity investors is that junk bond investors not only
assume balance sheet risk– as do other corporate bond investors — but, due to
the marginal credit quality of the firms that issue these bonds, these investors
are also very aware of changes in the economy, as the performance of their
holdings is contingent on these macro developments. Therefore, equities should
perform similarly to their junk bonds.
As can be seen in the chart below, the junk bond spread has good indicator of
major S&P 500 trend reversals–such as in 2000 and October 2002.
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