It sure looks like things are about to get really ugly, really fast.

Let’s take another look at the most dangerous chart in the market…

When we looked at this chart of the iShares iBoxx High Yield Corporate Bond Fund (HYG) last week, I warned that a breakdown here could spell trouble for the broad stock market.

You see, the action in “junk” bonds tends to lead the action in stocks. And, it sure looks like the junk is breaking down.

Despite the strength in the stock market early this week, HYG couldn’t rally above the resistance of its various moving average lines. Now, it’s struggling to hold above support. A close below $85.95 would signal a breakdown on this chart. And, that would bring the support line at $84 into play.

In other words, junk bonds are on the verge of giving up all the gains they’ve made since November.

Now, imagine if the S&P 500 did the same thing…

Granted… This chart looks a whole lot better than the chart of HYG. The S&P 500 is trading above all of its various moving averages. Those lines should offer, at least, temporary support on any declines.

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Remember though, junk bonds lead the stock market – not the other way around. The weakness in HYG over the past month is a BIG red flag of caution for the broad stock market.

If HYG breaks down from here, and heads towards the $84 support line, then the stock market is in trouble. A similar move in the S&P 500 gives us a target near 3570.

That’s just about a 10% decline from here.

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Of course, it doesn’t have to play out that way. HYG hasn’t broken below support yet. It’s possible buyers could step up here and rally the junk bond market back above all of its various moving averages.

But until that happens, traders should be cautious. It looks to me like there’s a lot of risk to this stock market, and not so much reward. I’d rather be a buyer after a 10% decline in the S&P 500 than before one.

Best regards and good trading,

Jeff Clark

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