A Long Term Trend of Lower Highs

While perusing the excellent chart collection of our friend Nick Laird (a.k.a. 'Sharelynx'), we came across a chart we haven't looked at in quite some time. Due to the information overload we all are exposed to nowadays, one sometimes forgets about things – in this case, a tried and true measure of investor confidence in corporate debt. We remember checking up on this measure regularly back in the 1980s: namely the Barron's Confidence Index.

What the index measures is simply the ratio between the Barron's Best Grade Bond Index and the Barron's Intermediate Grade Bond Index. When investor confidence in the economy and the quality of corporate debt is high, the index will tend to rise, when it is low, it will tend to decline.

To be sure, the index is not a 'timing' device; its usefulness for short term traders is rather low. However, it does provide us with interesting qualitative information. From a 'technical' perspective, it is noteworthy that the index at times confirms  stock market trends and at other times fails to do so. We believe that this does indeed tell us something about the long term health of the market and the economy.

Here is a 20 year chart of the index:

The Barron's Confidence Index (BCI) over the past 20 years – click to enlarge.

It is interesting that a long term downtrend in corporate bond market confidence appears to be underway. Over the years, investors have trusted lower graded debt less and less, something that the Confidence Index shows quite clearly, in spite of the spectacular demand for junk bonds and other dubious debt securities that has emerged in recent years.

BCI Divergences from the Stock Market

The other noteworthy fact is that the Barron's Confidence Index (BCI) has diverged significantly from the stock market at the two major peaks of the past 15 years. There were  notable divergences in evidence both in 2000 and again in 2007.

Given that these divergences have slowly built up over a span of several years in both cases, they can obviously not be used for timing the market. We would however argue that every time the stock market streaks to new highs and the Barron's Confidence Index merely manages to put in a lower high, it is a sign that the stock market's advance is unlikely to be sustainable. Something is wrong, or as Tonto would say: “It's too quiet”.

The S&P 500 index over the same time span. It is once again diverging from the Confidence Index, but the divergence is even more pronounced this time around – click to enlarge.

Lastly, here is an even longer term chart of the BCI over a span of 35 years. What this long term chart shows us is that the confidence of bond market investors has begun to take a significant turn for the worse when Greenspan's 1990s stock market bubble began to 'go parabolic' in the mid 90s, which went hand in hand with an unheard of expansion first in private and later in public debt.

The BCI over 35 years – click to enlarge.

We find it also quite interesting that confidence evidently crumbled really badly after the Nasdaq bubble expired in 2000. Readers may recall that Federal Reserve and other government officials at the time often stressed how well everything had worked out, as the recession was officially considered quite mild.

Of course the main reason for its mildness in terms of 'GDP' growth was that the housing bubble started almost immediately after the technology bubble had keeled over. And yet, it seems investors were not fooled at the time. Obviously, they distrusted the post 2000 recovery/real estate bubble era as well, given the lack of enthusiasm reflected in the BCI – and they seem to distrust the current 'echo bubble' era even more.

Conclusion:

The fact that the BCI has apparently just put in a lower high again represents yet another long term warning sign for the current boom in 'risk assets'.  The list of such warning signs is getting longer.

Charts by: bigcharts, sharelynx