The junk bond market broke down last week.
We’ve been watching and warning about the action in the iShares iBoxx High Yield Corporate Bond Fund (HYG) for a few months now. As recently as last week, HYG looked vulnerable to a breakdown. And now it’s finally happened.
Here’s the updated weekly chart…
HYG finished last week below the support line of its rising wedge pattern. It also closed below its 9-week exponential moving average (EMA). This action brings the 50-week moving average (MA) line into play as the next support level.
Given the negative divergence on the MACD and RSI momentum indicators, there’s a high probability that HYG is headed lower from here over the intermediate- and long-term timeframes.
Remember, though… this is a weekly chart. So it’s going to take some time to play out.
But no matter how you look at it, this is a major warning sign for the U.S. stock market over the next several weeks.
The action in high-yield bonds tends to lead the action in stocks. It’s the whole “risk-on, risk-off” relationship.
When investors are hungry for yield and willing to take a risk on junk bonds in order to capture a slightly higher yield, they’re also willing to aggressively buy stocks. When investors turn away from risk and they start selling junk bonds, they’re also quite likely to start selling their stocks.
This is the first major breach of the high-yield market uptrend since the decline last October. Back then, HYG fell 4% in about three weeks. The S&P 500 matched the decline over the same timeframe.
If HYG does pull back towards its 50-week MA line over the next few months, that will equal another loss of about 4%. That doesn’t sound too bad.
But if last week’s modest 1% drop seemed stressful, think about what a 4% drop will feel like. Then, adjust (or not) your trading plan accordingly.
Best regards and good trading,
Jeff Clark
P.S. You might have noticed a new feature added to the site this morning… an option trading glossary.
You can access it by clicking on the top-right tab on the website homepage—or here—and it’ll help you define the common (and some uncommon) option trading terms used in my analysis.
Reader Mailbag
If you have a question about trading options, the action in the broad stock market, or just a suggestion for the Market Minute or Delta Report, let me know right here.
Here’s what’s come in to my inbox recently from readers…
Thanks to your discussion about HYG on Aug 7 and 8th, I bought HYG weekly put options on the 8th and closed them on the 10th for a 110% gain. Yahoo!! I look forward to your daily analysis.
– Tim
I'm finding your analysis incredibly helpful the last few months that I've been a member of the Delta Report, thank you. Staying calm and lightly positioned with gold and short high yield bonds just might reap some rewards yet. I've managed to make a bit with DAL, CCJ, and XOM in recent weeks which I consider great going in these tedious market conditions.
– Mike
Thank you so very much for the archives search feature on your website. I use it constantly.
– Mark