Junk bonds may be signaling an end to the stock market rally.
High-yield corporate bonds have been steady performers this year. The iShares iBoxx High Yield Corporate Bond ETF (HYG) traded at its highest price ever last month.
And, since the action in junk bonds tends to lead the action in the broad stock market, we didn’t have to worry too much about a stock market decline.
In fact, it was just one month ago – while the S&P 500 was selling off in a sharp decline to kick off September – when we suggested it was too early to be betting on a stock market crash.
HYG was acting well. And, as long as it continued to do so, the broad stock market should hold up just fine.
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.
As we’ve noted many times here in Market Minute, high-yield bonds are a leading indicator for the stock market. HYG tends to lead the action in the S&P 500 by anywhere from two days to two weeks.
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When junk bonds are rallying, it’s a risk-on environment. That tends to be bullish for stock prices.
When high-yield bonds are falling, investors are in a risk-off mode. That’s bearish.
Since HYG has been declining for about two weeks, the action suggests we are entering a risk-off environment. A further decline in HYG is likely to start pulling down the stock market.
Best regards and good trading,
Jeff Clark
Editor, Market Minute