If you want to know when the stock market will start its next decline phase, then keep an eye on junk bonds.
High-yield bonds, also known as “junk bonds,” help to gauge investors’ appetites for risk. When junk bonds are rallying, it’s a “risk-on” environment. And, stocks do well.
But, the story changes when high-yield bonds are falling in price. Investors are getting rid of risky assets. And, in this sort of “risk-off” environment, stocks tend to fall.
Junk bonds went into risk-off mode in late February. That corresponded with the quick decline we saw in the broad stock market. Junk has popped a bit higher this week – which has helped support a bounce in stocks.
But now, junk bonds are approaching an important level. The next move is going to be quite important.
Take a look at this chart of the iShares iBoxx High Yield Corporate Bond Fund (HYG)…
After declining in October, HYG spent the next four months riding all of its moving averages higher. The moving averages were in a positive configuration… With the 9-day exponential moving average (EMA – red line) above the 20-day EMA (green line), and the 20-day EMA above the 50-day moving average (MA – blue line). It was a pure, risk-on environment.
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That changed, however, at the end of February when HYG dropped below all of its moving averages. And now, the MAs have shifted bearish… With the 9-day EMA below the 20-day EMA, and the 20-day EMA below the 50-day MA. Junk bonds have moved into risk-off mode.
In this sort of setup, the various moving average lines will now offer resistance on any rally attempts.
HYG has bounced this week. It’s now challenging the resistance of those moving average lines. If it can break out above resistance, then the junk bond sector will be back into risk-on mode. And, this week’s rally in stocks will likely continue.
On the other hand, if resistance holds and HYG turns lower from here, then stocks are headed lower as well.
Either way, traders should keep a watchful eye on the action in HYG over the next few days. It will signal where the broad stock market is headed.
Best regards and good trading,
Jeff Clark
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