It’s too early to bet on a stock market crash.
There’s nothing wrong with being cautious. And there’s nothing wrong with trimming some long positions and raising some cash. We’ve suggested as much over the past few weeks here in Market Minute.
But betting aggressively on the downside right now is probably a mistake.
Yes, stock valuations are stretched. Yes, we’re in the seasonally weak period of September and October. And yes, there’s a bunch of political chaos that could add uncertainty to the financial markets.
But until the high-yield bond market breaks down, the stock market isn’t going to crash.
High-yield bonds are a leading indicator for the stock market. 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.
And the iShares iBoxx High Yield Corporate Bond ETF (HYG) has been climbing higher since April.
Here’s the chart…
I don’t see anything bearish in this chart. HYG is trading above all of its various moving average (MA) lines.
And those MAs are in a bullish configuration – with the 9-day exponential moving average (EMA) trading above the 20-day EMA, and the 20-day EMA above the 50-day MA.
If the stock market was setting up for a crash, then the chart of HYG would be leading the way lower. But that’s not happening… yet.
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The action in the junk bond sector suggests last week’s decline in the broad stock market was nothing more than a short-term dip.
Traders, though, should keep an eye on junk bonds for the next few weeks.
If HYG starts to break down and lose the support of its MAs, then we’ll be setting up for a more significant decline in the stock market. That will be the time for traders to add short exposure.
It will happen at some point… just not right away.
Best regards and good trading,
Jeff Clark
Editor, Market Minute