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Junk bonds are signaling an end to the stock market rally.
High-yield corporate bonds enjoyed a fantastic rally in April. The iShares iBoxx High Yield Corporate Bond ETF (HYG) gained 3% from its bottom in late-March to its mid-April high. That’s a phenomenal move for a bond fund.
And, as we’ve discussed many times here in Market Minute, the action in high-yield bonds leads the action in the stock market by anywhere from two days to two weeks. That’s because junk bonds show us investors’ appetite for risk.
In a “risk-on” environment – where investors are willing to chase prices higher – high yield bonds rally first. When the environment shifts to “risk off,” and investors start pulling money out of the markets, junk bonds are among the first assets to get sold.
So, in hindsight, it’s no surprise the stock market enjoyed a fantastic rally in April as well. Junk bonds signaled a “risk-on” move heading into April. They’ve been helping to power the stock market higher ever since.
Now though, the picture has changed.
Take a look at this updated chart of HYG…
HYG has been declining for the past two weeks. It’s now trading below its 9- and 20-day exponential moving averages. And those moving averages are starting to turn down – indicating a more significant decline may be in the making.
This is a notable divergence to the action in the stock market, where the S&P 500 has been making new highs.
We saw a similar divergence in February – when HYG started to decline at about mid-month, while the S&P 500 held up near its high. That divergence was an early warning sign to the stock market decline investors suffered through in March.
It looks like HYG is giving us another early warning sign.
HYG has been declining for about two weeks. This sort of action suggests we are entering a risk-off environment.
The old stock market adage, “Sell in May and go away,” hasn’t worked so well in recent years. The S&P 500 has pressed higher in May in eight of the last 10 years. So, a lot of folks think the old adage doesn’t carry much weight anymore.
But, if HYG keeps falling, that old saying might come back into vogue this year.
Best regards and good trading,
Jeff Clark
Editor, Market Minute
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