With the volume and velocity of information out there, trying to get a read on the stock market is like attempting to get a sip of water from a firehose. Thankfully Paul Schatz of Heritage Capital has three ways to check the health of the market and durability of its trends. They don't work every single time but Schatz says these are great "tells" as to whether or not what's happening from day to day is reality or a mirage.
1. High Yield Bonds (HYG)
More commonly known as "junk bonds," high yield corporate debt has been one of the favorite plays for investors who want decent cash flow with slightly more safety than stocks. Historically low rates on U.S. Government debt have made junk bonds an attractive way to play in between bonds and equity.
That's why junk is the canary in the coal mine according to Schatz. Risk appetites should be relatively consistent across the board. In other words, if stocks are rising, corporate debt should be moving higher as well.
"If the market rallies and high yield does not participate that's worry sign number one," says Schatz.
2. S&P 400 Mid-Caps (^MID)
The S&P400 is a measure of stocks not quite big enough to make the cut for the S&P 500 (^GSPC). Companies this size tend to be hit harder by economic fluctuations than those with larger balance sheets or more lines of business. This makes the mid-caps a way to gauge the real health of the earnings environment for corporate America.
"Traditionally in bull markets mid-caps lead," Schatz says. When the S&P 400 isn't leading, or at least playing along with a market rally, it's time to take profits.
3. Dow Jones Transportation Index (^DJT)
As would be expected, the Transports are a collection of 20 American companies in the business of moving things from point A to point B. Railroads, airlines, and trucking basically. Even in a virtual age most traders regard the Transports, or "Trannies" as a good gauge of underlying economic activity.
By market tradition, real bull markets only come when both the Dow Jones Industrial Average (^DJI) and the Transports are breaking out together. At the moment there's little risk of either happening, but Schatz suggests traders stay on the lookout.
"If the Dow Jones Transports can take out the April highs I think it's a straight 5 - 10% shot higher," he says. Though he concedes it's a "long way to Tipperary" before they do.
