I’ve been very loud lately that the credit event may be underway, and that Treasuries are it. There has been an absolutely incredible collapse in long-duration Treasury prices (spiking of yields), despite talk of a Fed pause and ongoing short positioning in Treasuries (which keep working, clearly). This can only last for so long. The speed with which Treasury yields have been spiking presents a danger to everyone.
What would stop the Treasury crash it seems we are in now? Likely it would be a stock market collapse, forcing the flight to safety trade right back into Treasuries.
Now, admittedly, I have a bias in this sequence as it relates directly to my approach, my papers and my own investment strategies. But I don’t think that’s far-fetched. I find it eerie that Treasury yields are surging just as the correlation of the Nasdaq-100 year-to-date to the Dow Jones Industrial Average in 1987 reaches 0.87.
I’ve been wrong plenty of times in the past, but I do think the movement on the long duration side, in terms of speed, can’t persist much longer. Additionally, I believe a strong melt-up comes back into place for Treasuries as stocks breakdown. The sentiment against Treasuries and narratives are as strong, if not stronger, than what was heard from the stock market bears in October of last year when I screamed “stock market melt-up.”
The Flippening Is Coming
This is where this silly term “the Flippening” comes into play. Those who have followed me know I come up with terms to describe my views on probabilities favoring a particular sequence. The Flippening is the idea that large-cap technology stocks no longer become seen as the flight-to-safety trade of choice. That instead of stocks being the place to be in a bond market dislocation, it ends up being bonds themselves that rally (to be clear, Treasury bonds) as stocks break down and junk debt gets slammed. It’s the return of more classic risk-off, which existed long before the 40-year bond bull market began in the early 1980s.
For the Flippening to take place, credit spreads need to widen. Junk debt needs to meaningfully weaken relative to Treasuries. When we look at the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) relative to the SPDR Barclays Long Term Treasury ETF (NYSEARCA:SPTL), the uptrend suggests credit spread narrowing is the bubble. The Flippening idea breaks this, causes the ratio to fall hard, and brings back Treasuries from the dead as risk-on assets turn aggressively volatile. The real credit event.
If Not Now, When?
I don’t know when. But if not now, when? I have flagged this as a high-risk juncture and maintain that view. The speed of rates and disorderly movement going on in the pristine asset of Treasuries can only last so long. And stocks can only turn a blind eye to the cost of capital until it gets hit in the face. When it does, watch out — conditions favor it.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
