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<\/p>\nHigh-yield bonds are flashing a warning sign.<\/p>\n
“Junk bonds,” as high-yield corporate debt is often called, help gauge investors’ appetites for risk. When junk rallies, it’s a “risk-on” environment – and stocks tend to do well.<\/p>\n
But when junk bonds fall in price, investors reduce their risks. And in this sort of “risk-off” environment, stocks tend to fall.<\/p>\n
The good thing for traders is that the action in junk bonds tends to precede the action in the stock market by anywhere from a few days to a couple of weeks.<\/p>\n
So, traders can use the action in junk bonds to indicate the future direction of stocks.<\/p>\n
And right now, junk is looking lower. Look at this chart of the iShares iBoxx High Yield Corporate Bond ETF (HYG)…<\/p>\n
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HYG has put on a good rally since the end of October. Of course, that “risk-on” action has coincided with a record-breaking rally in the stock market.<\/p>\n
But HYG has been struggling for the past few weeks. It is trading below the all-time high it posted in December. The blue line shows that HYG recently closed below its 9-day exponential moving average (EMA).<\/p>\n
The red arrows on the chart point to previous times when HYG closed decisively below its 9-day EMA.<\/p>\n
Here’s how the S&P 500 behaved during those selloffs in the junk bond market…<\/p>\n
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In four of the five previous cases, the S&P 500 followed the junk bond market lower.<\/p>\n
Last February, for example, the index dropped nearly 300 points in just four weeks. In August, we got a 200-point drop in two weeks – followed by a nearly 400-point decline in September.<\/p>\n
HYG peaked about four weeks ago. Yet the broad stock market has managed to push higher.<\/p>\n
However, since high-yield bonds tend to lead stocks, the recent rally in the S&P 500 is on shaky ground.<\/p>\n
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