If you’re looking for signs of a stock market bottom, then pay attention to junk.
High-yield bonds (a.k.a. junk bonds) are the ultimate barometer of investors’ willingness to take on risk.
If the stock market is going to rally, then junk bonds will likely rally first. And, when the market is set to fall, weakness in high-yield bonds is often the “canary in the coal mine.”
We’ve written about this relationship between junk bonds and stocks many times here in Market Minute.
The action in high-yield bonds tends to lead the action in the broad stock market by anywhere from two days to two weeks.
That relationship should inspire some hope among the stock market bulls. It looks like high-yield bonds are setting up for a rally.
Take a look at this chart of the iShares iBoxx High Yield Corporate Bond Fund (HYG)…
HYG has been crushed this year.
The fund is down almost 6% in two and a half months. That’s an enormous move for a bond fund. Investors have clearly been in “risk-off” mode, and HYG has been leading the stock market lower.
But there are signs that this trend could soon change…
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While HYG has recently fallen to a lower low, the various momentum indicators at the bottom of the chart (MACD and RSI) have made higher lows. This sort of “positive divergence” is often an early warning sign of a potential trend change from bearish to bullish.
This is the first time in this three-month-long decline phase that we’ve seen positive divergence on this chart.
So, it’s likely telling us that a significant intermediate-term bottom is near. And if high-yield bonds start to rally, then a stock market rally shouldn’t be far behind.
Traders should pay attention to the action in HYG this week. It’ll tell us whether or not stocks are ready to rally.
Best regards and good trading,
Jeff Clark
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