Investor Confidence Measurement: 3 Effective Tools
An article by New York Institute of Finance instructor Deb Weir.
Investor confidence is one of the main drivers of equity markets. You can measure the strength of investors’ fear and greed by looking at the changing prices of Treasuries (that safe-haven during times of fear) compared to that of high-yield bonds (representing greed, or a desperate reaching for income). As their returns converge or diverge, you can almost feel the change in the stock market’s emotional temperature. This spread often precedes a turn in the stock market.
Below are three websites that provide a window into investor confidence. We will examine the strengths and weaknesses of each one. The bottom line is that you can use any of them as long as you have a previous period for comparison. The point is to see how sentiment is changing.
1. Federal Reserve Bank of St. Louis data
The Federal Reserve data at the St. Louis Fed (FRED), is very easy to access and read. You can register for daily email delivery with this link to the appropriate page http://research.stlouisfed.org/fred2/series/BAMLH0A0HYM2
The graph puts things in perspective. The shaded areas are recessions, so it becomes obvious that investors take refuge in safe Treasuries as recessions approach. The difference between yields in safe Treasuries and bonds with more risk, or high yields, increases during difficult economic times. Conversely, this spread narrows as good times return, confidence improves, and we may expect the stock market to deliver delicious returns.
You can drill down to the five most recent observations so you can see the direction of investor confidence. In this example from April 30 to May 6, the spread is narrowing and investors are feeling better. We might expect the stock market to improve under such conditions. In fact, the DJIA closed above15000 and the S&P exceeded 1600, which were historical highs, on May 7th.
Here is the ten-year record of this spread forecasting the stock market:
The spread was a powerful indicator of trouble in late 2007 through March 2008. The 250 basis point spread persisted at this historically low level for a long time. When it finally expanded late in the summer of 2007, investors may have known that fear was overtaking greed in the bond market. Soon it would infect stocks as well.
The spread reached another historical level of 2020 basis points in early 2009. When it started to contract, there was an indication to get back into the stock market a little later that year. Recently there has been an indication to buy.
The high-yield indices used in all three of our websites include foreign as well as domestic bonds. This indicator was one of the few suggestions of trouble in 1998 before the Russian bond failures triggered a 20% loss in six weeks in the S&P index. You can download all 14 years of FRED data to see the story.
2. Merrill-Lynch High-yield Constrained Index
FRED is market-capitalization weighted so that a large, highly-priced issue may dominate the data. The next website presents an index that spreads the data more evenly among issues.
The Wall St. Journal’s page for the Merrill-Lynch High-yield Constrained index limits each issuer to 2% so that large issues will not dominate the data. http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html
While this information spreads the weightings more than that on FRED, it is a little more difficult to use. For one thing, you must subtract the yield on the ten-year note from Merrill’s index in order to see the spread. Bloomberg provides a convenient source for the ten-year: http://www.bloomberg.com/news/bonds/ Then you have to compare that spread with that of the previous day to see the direction of change. The larger problem is that the site does not publish it every day. Some days the n/a stays on the page all day. It is disconcerting to see that the index is unavailable. I always worry that investors have abandoned the market, there is something wrong with the data, or there is a flash crash somewhere in the system. Furthermore, the index disappears every night; there is no repository of historical data for your scholarly pursuits.
3. Junk bond ETF
Both of the previous indicators provide information generated after the close of markets on the previous day. The third website is more timely and makes historical data available.
SPDR® Barclays High Yield Bond ETF (JNK) trades throughout the day. https://www.spdrs.com/product/fund.seam?ticker=JNK You still have to do the math and then compare the spread to that of the previous period. Hopefully, you saved the spread from that previous period. The good news is that you can read investor confidence all day long and track its changes. You can access historical data of both the ETF and the ten-year note if you need previous information.
Any one of these three simple measures of investor confidence can be extremely useful when making asset allocation decisions.
About New York Institute of Finance
With a history dating back more than 90 years, the New York Institute of Finance is a global leader in training for the financial services and related industries with course topics covering investment banking, securities, retirement income planning, insurance, mutual funds, financial planning, finance and accounting, and lending. The New York Institute of Finance has a faculty of industry leaders and offers a range of program delivery options including self-study, online and in classroom.
For more information on the New York Institute of Finance, visit the homepage or view in-person and online finance courses below: