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.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

 

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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.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE Newsletter.

Insider Selling of Stocks is at Highest Level for the Year

Insiders are fearful of an impending sell off. When this happened earlier this year the S&P 500 quickly declined 10%. Other sentiment measures are reaching extremes too, but there’s a silver lining.

All major U.S. stock indexes continue to trade near multi-year highs, but insiders are selling stocks of the companies they own or manage at a pace not seen at any other time in 2012.

Investors Intelligence reports eight sales for each purchase and considers the current rush for the exits “panic selling.” The question we should ask is, “what do insiders know that we don’t?”

Another sentiment extreme can be seen in the high yield bond market, more appropriately called junk bonds. Companies just issued the third-highest amount of junk bonds.

The prior records were set in October 2010 and May 2011. Those two dates are marked in the chart below. I’ll explain in a moment the significance of those two dates.

Mutual fund managers tracked by the National Association of Active Investment Managers report that managers have a median exposure of 95% to equities. This is close to a six-year high and sets an 18-month record.

The Dow Jones just went an entire quarter without losing more than 1%. Jason Goepfert with SentimenTrader took a look at what happens historically when the Dow goes an entire quarter without a 1% decline, while trading close to a 52-week high.

There were 16 such instances since 1900. Over the next six months, the Dow was positive every time with a median return of +6%.

Getting back to the two dates highlighted in the chart above, we are currently in a situation where sentiment is becoming extreme. But just as Advil covers up pain, QE3 tends to neutralize extreme optimism.

Back in October 2010 it took several months before sentiment extremes caught up with stock prices. In May 2011 however, it resulted in a nasty sell off.

From a seasonal perspective October is an interesting month. It has hosted a number of crashes but also a number of important lows.

Looking at stocks, we see that the S&P 500 (S&P 500 SPDR – SPY) has been trading in a well-defined parallel trend channel. The strategy – as long as the S&P remains within this channel – is to sell when it reaches the top of the channel and buy at the bottom.

Once the bottom (of the channel) falls out, it’s probably time to become more bearish.

The Profit Radar Report monitors literally dozens of sentiment gauges, seasonal patterns, and technical developments to identify high probability investment opportunities for the best investment strategy.