This is a dangerous situation.
It’s not obvious. Major turning points in the financial markets rarely are. Nobody rings a bell at the top of a bull market, right?
But Quasimodo is hanging out in the high-yield-bond bell tower. And he’s just about ready to pull on the rope.
Normally in the Market Minute, we take a look at how the broad market is shaping up for the day’s trading.
But every week or so, I’ll explain a different technical indicator – like we did with VIX options in late April. Today, that indicator is high-yield bonds.
Take a look at this weekly chart of the iShares iBoxx High Yield Corporate Bond Fund (HYG)…
HYG – a junk bond ETF – rallied to a new all-time high yesterday. That’s a bullish development for stocks.
You see, the stock market and the junk bond market tend to move in the same direction. It's the classic “risk on/risk off” relationship. When investors are willing to take on risk to seek higher returns, they flock to stocks and high-yield junk bonds. When investors turn conservative and seek to protect capital, they sell stocks and junk bonds.
So, with HYG rallying to a new high, stocks are likely to follow.
It’s “risk on,” baby. The stock market is in rally mode.
Traders just can’t be bearish here. The upside momentum is too strong to fight. So, if you’re bearish on the stock market, you’re better off sitting in cash on the sidelines than trying to fight the bullish momentum.
But you won’t have to wait on the sidelines for too long.
Here’s the thing… This is a weekly chart. So, this is a long-term condition. And, if we look at it objectively, then there’s a reason for concern.
HYG is forming a rising wedge pattern with negative divergence on the MACD (moving average convergence divergence) momentum indicator. This pattern almost always ends with a breakdown. That’s bearish. And, if HYG turns bearish, then the broad stock market won’t be far behind.
There’s still room inside the pattern for HYG to continue higher. And as long as that potential exists, we have to respect the uptrend.
That’s why – despite my personal bearish stance – I’ve been unwilling to recommend short positions and I’ve argued that stocks are still headed higher.
But keep an eye on this weekly chart of HYG. It’s nearing the apex of the wedge pattern. And as soon as it breaks down, the broad stock market will likely break down as well. And, since this is a weekly chart, the trend reversal will likely last for several months.
Best regards and good trading,
Jeff Clark
P.S. I love to hear your feedback. Send any questions, concerns, or great trades you’ve made to me right here. Here’s what’s come in recently… with my comments.
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Comment: I have been reading your daily updates regularly and I see that momentum indicators, support and resistance, trend line and stock patterns play a significant role in your work. Do you put any value in Elliott Wave Theory? – Edward
Jeff's response: Elliott Wave Theory is a form of technical analysis used by lots of smart traders. But, like many theories, it’s better used as a way to explain “what happened” than it is as a way to project what will happen.
EW does help to confirm the strength or weakness of patterns (for example, wedge patterns have a higher potential of playing out if they have five waves). It also helps define impulsive moves that are likely to continue – and corrective moves that are likely temporary. For the most part, though, I find there are just too many variables and conditions in EW Theory to use it consistently.
I prefer to just keep it simple… look for patterns that have played out in the past and will likely play out again, look for extreme conditions in the technical indicators to set up a possible “reversion to the mean” type of trade, and look for extremes in investor sentiment.
If those trade conditions happen to fall in line with EW Theory as well, then that’s all the better. But it’s more accidental than on purpose.
Comment: I am a day (swing) trader and would greatly appreciate Jeff's insight on any indicator (or anything) that would help us day traders recognize a legitimate intraday trend (leg) reversal. Thank you (hoping for something real to help us). – Will
Jeff's response: Today’s essay is for readers like you, Will. As I mentioned above, I’ll try to write one essay every week or so that explains a different technical indicator.