The New Era Of Trading Stocks Off The Credit Markets

Good afternoon all. Today, rather than diving into the nitty gritty of the markets, I’d like to post an outline of why and how I tend to focus my attention and writings on the corporate bond market and related credit market derivatives. And how that affects my trading choices and strategies.

First off, I want to make it clear that I am not a bond trader; I trade stocks and options. Therefore it would be a lot easier if equities traded on their own fundamentals and/or on macro trends; but unfortunately, as anyone who pays attention to the market knows, that’s not the case, and it has not been the case for almost two decades.

The dynamics that have driven stocks up and down in a series of booms and busts since the late ‘90’s have all centered around the corporate bond market. Having been raised to believe that stocks should reflect the discounted valuation of company’s earnings and earnings prospects, accepting alternatives reasons for the rise and fall of equities has not been easy. But after years of reading the writings of Rosenblatt’s Brian Reynolds, watching the correlation between the credit market and equities market and digging into data that supports in no uncertain terms Brian’s thesis, I have now come to accept that the equity markets are what they are, and not what we want them to be.

There are two parts to reading credit as a guide for equities. The first involves the drivers of money flows into credit funds, i.e. the yield chase by large institutions (pensions, endowments, foundations, etc.) which outsource the management of their fixed income investments. This is something that Brian speaks often about during his appearances on CNBC, so, rather than paraphrasing him, you can see and listen to him explain the mechanics in this recent video.

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The second part deals with interpreting the week-to-week and/or day-to-day moves in credit and credit derivatives spreads. That’s trickier, particularly as one scales down on timeframes. Once again, over many years, Brian taught me what credit measures to watch and how to assimilate the zigs and zags of credit as they may pertain to stocks. I’ve written several articles on that for (now T3 Live), but the pieces linked here offer a summary and an example of how I applied those measures to the April 2014 stock market correction.

In addition to the above guides, I overlay two tools to my credit and equity reads. The first is a derivative of the Volatility Index (VIX). I tend not to focus on the spot VIX because a.) too many people are fixated on it, and b.) to observe that there’s a lot of fear/complacency in the here-and-now doesn’t really help in determining how long such mood may last.

Rather I prefer to watch the curve of the VIX. The how and why I do this is explained here.

The second tool is DeMark analysis. DeMark analysis is technical analysis through the lenses of buying/selling exhaustion measurements created by Tom DeMark. It is somewhat arcane and it involves some pretty precise risk management rules, so I would urge anyone interested in it to read up and understand the core components, rather than just pick up snippets here and there and then lament that “DeMark didn’t work”. Jason Pearl has a gem of a book on the subject that you can purchase here. It condenses the important stuff in a very readable way even for the novices.

However, if you simply want to have a sense of what I’m talking about when I write or tweet about DeMark indicators, this little primer I wrote may do the trick.

I appreciate that this is a lot of content to go through, but it will make my future articles on See It Market much more understandable and, hopefully, a useful source for navigating the markets.

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No positions in any mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.