What Does the Junk Bond Meltdown Mean for Stocks?

In the land of the blind, the one-eyed man is king.

In the land of low interest rates (ZIRP), high yield junk bonds are king. Never mind the additional risk. At least that’s how it used to be.

But reality has a tendency to make unexpected appearances, and it certainly made its presence known to yield hungry and risk ignorant junk bond investors.

Starting in June 2014, junk bonds turned sour.

The Profit Radar Report doesn’t often touch on junk bonds, but the July 5, 2015 Profit Radar Report mentioned junk bonds’ role in a developing bear market:

The Greek drama is fueling a fair amount of crisis talk. We anticipate an equity correction soon and a full-blown bear market eventually (2016?), but that doesn’t mean other asset classes can’t turn down sooner.

Economic recessions are a diffuse process, not a sudden all-encompassing event. Investors with money in high yield funds should watch support levels and exercise appropriate risk management.

The SPDR Barclays High Yield Junk Bond ETF (JNK) is trading near support at 38.21. A break below support should be a warning for junk bond investors.”

JNK lost 20% since June 2014, and 13% since violating support at 38.21.

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It looks like junk bonds have entered a bear market already.

JNK may catch a bid around support at 33.30, but there are no bullish divergences. A move above the lower trend channel line is the minimum requirement to pause the selling for more than a week or two.

The junk bond decline has robbed investors (particularly retirees) of yet another income source.

Yes, economic recessions are a diffuse process, and junk bonds may be one of the first asset classes to drift into a new bear market.

Simon Maierhofer is the publisher of the Profit Radar ReportThe Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

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Junk Bond ETF Approaches ‘Make it or Break it’ Point

We’ve all heard the ‘canary in the mine’ analogy. Bond investors are said to be smarter than stock investors and thus considered the canary in the mine. If that’s true, the SPDR Barclays Junk Bond ETF is about to chirp.

It’s said that bond (NYSEArca: AGG) investors are smarter than stock investors.

Stocks are not quite sure how to react to the budgetary/debt ceiling standoff, so we definitely can use a fair amount of ‘smarts’ right about now.

High yield bonds (or junk bonds) are the closest relative stocks have in the bond family. This is due to their elevated yield and risk levels.

So what kind of clues does the performance of high yield bonds provide for stocks?

The SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) chart below shows some seemingly important support/resistance levels for JNK.

The green line has provided support since June. The descending red line has offered first resistance and now support. Both lines meet today at 39.70.

The situation for the iShares iBoxx $High Yield Corporate Bond ETF (NYSEArca: HYG) looks similar, although HYG has a bit more room before it hits support around 90.70.

The above chart also plots JNK against the S&P 500 (SNP: ^GSPC) to illustrate the correlation between junk bonds and stocks.

Quite frankly, based on this chart the correlation between stocks and junk bonds looks more like a myth.

JNK trades at the same level today as in November of last year. The S&P 500 (NYSEArca: SPY) on the other hand is up 25% since November 2012.

Now the question is if further weakness for junk bonds would spell trouble for stocks?

Not necessarily, purely based on the lack of direct correlation.

However, JNK is just above support, and a case could be made that the S&P 500 is about to break out of a bearish rising wedge.

What would that mean? The implications are discussed here: Will The S&P 500 be in Trouble if Support Fails?

Simon Maierhofer is the publisher of the Profit Radar Report.

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Weekly ETF SPY: Junk Bond ETFs Breakdown – Canary in the Mine?

Who is the best canary in the mine? It is said that bond traders are smarter than stock traders. Considering that junk bonds are showing cracks, it might be interesting what the ‘canary’ has to ‘chirp.’

‘Are Junk Bonds Ready to Fall?” – USA Today
‘Junk Bonds Flash Warning Signal’ – MarketWatch
‘Junk Bond Decline: Should You be Afraid?’ – Barron’s
‘Junk Bond Risk Climbs in Europe as January Issues Reach Records’ – Bloomberg
‘High-Yield Selloff Just Beginning?”

When times are good, junk bonds (or junk bond ETFs) are called high yield bonds. When times are bad, they’re called by their real name, junk bonds.

Based on the above headlines, high yield bonds have fallen out of favor. At least that’s the media consensus. What does technical analysis show?

The chart for the SPDR Barclays High Yield Bond ETF (JNK) doesn’t look impressive. JNK just closed below trend line support. The recent all-time high was also accompanied by a bearish RSI divergence.

Although the technical picture looks similar, the JNK breakdown is not confirmed by its ‘junkie cousin’ – the iShares iBOXX High Yield Bond ETF (HYG). HYG remains above trend line support.

Does HYG matter more than JNK or vice versa? Probably not. JNK trades more actively (4.3 M shares compared to HYG’s 3.5 M), but is smaller ($12.8 B vs HYG’s $16 B).

Anyone short JNK may use the red trend line as stop-loss guide. The prudent approach is to wait for HYG to confirm JNK’s breakdown.

JNK and HYG have both decoupled from the stock market. Bond traders are often considered smarter than stock traders and viewed as canaries in the mine. If that is true, stocks and bonds may be about to hit a rough patch.

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