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Why Junk Is a Better Bet Now Than Stocks

It holds up better than equities in a downturn -- which is coming


I’ve seldom seen stock market investors so contented as they are right now. It’s like the feeling you get after a big Thanksgiving feast — fat, happy, sleepy. Today’s new yearly high on the S&P 500 index (the 14th new 52-week closing high the index has registered in 2013) only deepens the sense of peace and safety.

Yet, in the room next door, Mr. Market is fumbling around, making noises with the furniture. He’s up to his old tricks, planning a little surprise for the unwary.

While most investors are leaning back in their easy chairs, the corporate insiders (officers and directors of America’s publicly traded corporations) have uncorked a torrent of selling in their own stock. Over the past eight weeks, according to Vickers, insider sell transactions have outnumbered buys for all listed shares by a whopping 5.2 to 1.

We’re closing in on the 5.5 ratio that has put the kibosh on even the most dynamic market rallies of the past six years. Strangely, though, few of the Nervous Nelly technicians who normally rant and rave over heavy insider selling are uttering a peep. The market’s vertical rise since year-end has stunned the bears into silence.

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Too bad for them, because the objective price evidence shows that the post-Nov. 15 advance is fast running out of steam. This chart will show you what I mean.

It plots the percentage deviation between the daily close of the S&P 500 index and its 10-day average. As you can see, this indicator peaked in early January. It has since made a series of lower highs (note the  trendline), diverging from the index itself, which has continued to rise.

This pattern of fading upside momentum is typical of a market advance in its mature stages. A “correction” is coming soon. The insiders know it, but the broad investing public doesn’t (yet).

How severe a setback? At this point, I’m not expecting more than 3% to 5% on the Dow or S&P. However, these things can sometimes get out of hand, as in the summer of 2011. Thus, at the very least, you should throttle back on your stock buying. I also advise you to sell stocks (or mutual funds) with high betas (high volatility characteristics). These investments are the most likely to get hurt in a general market retreat.

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Lately, we’ve heard a buzz of warnings — invariably from equity bulls — that the junk-bond market is in trouble. If these folks would only take a few minutes to study their charts, they’d realize how logically inconsistent this posture is.

Overlay a chart of any junk-bond ETF like the iShares iBoxx High Yield Corp. Bond ETF (NYSE:HYG) or SPDR Barclays Capital High Yield Bond ETF (NYSE:JNK) against a chart of the S&P 500. You’ll find an extremely high correlation. Except for one thing: The junk bonds hold their ground better than equities in a falling market.

Thus, it’s the height of folly to advise investors to sell junk bonds and buy stocks. If “junk” is going down, stocks are going down more!

My pick for exposure to junk is Wells Fargo High Income Advantage Fund (MUTF:STHYX). With its relatively short maturity structure, STHYX is safer than most other junk-bond funds — and much safer than almost any equity fund. Current yield: 5.7%.

Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk “value” approach has won seven “Best Financial Advisory” awards from the Newsletter and Electronic Publishers Foundation.

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