The junk bond market is selling off hard.

The less-than-investment-grade sector of the corporate bond market peaked about one month ago. The decline started slowly enough. But it picked up steam last week. And now, high-yield bonds are in free fall.

Here’s an updated look at the daily chart of the iShares iBoxx High Yield Corporate Bond Fund (HYG)…

I’ve showed you versions of this chart a couple of times over the past few weeks – just as the sector was starting to fall. Each time I warned that if the high-yield bond market breaks down, then the stock market should follow close behind.

It’s widely known that the action in the junk bond market tends to lead the action in stocks by anywhere from a couple of days to a couple of weeks.

Well, here we are… easily a couple of weeks into a sharp decline in junk bonds. Yet, the S&P 500 closed yesterday within 0.6% of its all time high.

This divergence was the topic of conversation on a financial network television show yesterday. The talking heads discussed the breakdown in high-yield bonds and noted that stocks didn’t seem concerned. That prompted the moderator to ask the most dangerous question on Wall Street…

“Is it different this time?”

To my disbelief, the talking heads agreed that conditions were different. They went on to explain why a breakdown in the high-yield bond market would not lead to a stock market selloff this time.

Their rationale centered on the fact that so many high-yield bonds were concentrated in the telecommunication sector. Weakness in that sector is isolated. Other companies in other sectors are not experiencing the same sort of “credit crunch.”

Nonsense. While HYG does hold about 3% of its portfolio in telecom company bonds, many of those holdings are still trading above par.

The rest of the portfolio is well-diversified amongst a variety of sectors including energy, manufacturing, technology, pharmaceuticals, health care, retail, and others. High-yield bond prices in all of those sectors have fallen over the past month.

This could very well be the start of a “risk off” environment – where investors lighten up on their riskiest holdings. Right now, that means selling off some junk bonds. Soon, it will mean selling off some of their more volatile stocks.

This IS a warning sign for the stock market.

I can’t tell you for sure when stocks will react to the selloff in junk bonds. It could be today. It could be a month from now.

The only thing I can say with confidence is it is most definitely NOT different this time.

Best regards and good trading,

Jeff Clark

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Reader Mailbag

How have you traded divergences like this in the past? Is it possible that it’s simply “different this time”?

Send in your thoughts… and any other questions or suggestions… right here.