When it comes to the world of finance, FEAR is to a rising market what a hot flame is to an air-filled balloon. The challenge comes in knowing beforehand when things are about to go “POP!”
And, because we're talking not about atomic particles but fear, the question is: How does one quantify emotion?
In our experience, one of the most reliable measures of collective investor emotion is the Junk-to-Treasury Yield Spread, or difference between low grade and high-grade debt. The two sides of the spectrum carry the following implications:
- Narrowing yield spread: The public takes greater risks in search of greater rewards. Feelings of optimism encourage speculation and spending, the two engines of economic growth. Stock markets rise.
- A widening spread: The public flees to safe assets. Feelings of pessimism dissuade risk-taking in any form. Stock markets fall.
Therefore, to observe major trend changes in the Yield Spread is like hitting the predictive mother load. Which is exactly what the September 2007 Elliott Wave Financial Forecast did. In that publication, our analysts presented a bold snapshot of the spread between the yield on the US Industrial B-rated 10-year Bond AND the 10-year US Treasury Bond.
At the time, the market was in its infant stages of a widening trend that kicked off in June. In EWFF’s own words: “Lehman, Bank of America, Barclays Say Rout Is Over.” We say: “It’s Just Beginning.”
Now, the June 2008 Elliott Wave Financial Forecast revisits that same chart and picks up where it left off. Below is an exact reprint:
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Editor’s Note: The most dramatic upsurge in the yield spread occurred right as the Dow Jones Industrial Average was nearing its October 9, 2007 all-time peak. Now, the
June 2008 Elliott Wave Financial Forecast reveals where the spread, and stocks, are headed next.
Learn More)
In his 2002 world-acclaimed book
“Conquer the Crash,” Bob Prechter foresaw that --when the psychology of fear woke from its bullish slumber, it would find the following bedfellows:
“When the social mood trend changes from optimism to pessimism, creditors, debtors, producers, and consumers change their primary orientation from expansion to conservatism. When lending officers become afraid, they call in their loans and slow or stop their lending no matter how good their clients’ credit may be in actuality. Instead of seeing opportunity, they see danger.”
Flash ahead to June 2008 and these recent news events:
- “Market Spotlight: Tighter Lending Standards” (CNN Money): On June 1, leading mortgage giant Fannie Mae debuted its new, stricter underwriting software. The modern program will “limit risk layering, assess each loan more precisely,” “significantly tighten eligibility standards,” and “reduce approval rates.”
- “Tighter Credit Environment” (Scripps News, DC): Describes the movement among U.S. mortgage insurers toward harsh “scrutiny” and severe “guidelines, including higher credit scores, bigger down payments, and documentation of income and assets. “Two years ago, borrowers could get loans if they fogged a mirror. Now, they give you a full medical exam.”
- This July, the Federal Housing Administration will start taking credit scores into account and consider rates on a case-by-case basis for the first time since its establishment in 1934.
Throw in “Consumer Spending At A Standstill” (AP), refund checks going to pay off credit card debt, and a growing movement against “speculation” -- and the wheels of change are clearly in motion.
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