Most risk assets, including high-yield bonds — as represented by the popular and very liquid iShares High Yield (ETF) (NYSEARCA:HYG) — had a rough start to the year. Unlike stocks however the HYG ETF has been steadily drifting lower since topping out in 2013 and increasingly looks to be ready for a major oversold rally. Traders and active investors take note.
Although the S&P 500 closed near the unchanged line for 2015, market breadth was much worse below the surface. Another way at looking “below the surface” is by paying attention to other asset classes for leading indicator signals.
Myself and my circle of hedge fund professionals spent much of the past 12 months closely following other markets such as high yield and emerging markets where the stench of something wrong has gotten worse by the month.
HYG Stock Charts
To reiterate the disconnect between reality and “on the surface,” on the below chart I plotted the S&P 500 benchmark equity index in blue versus the high yield HYG ETF in red. While the S&P 500 stubbornly held up through most of 2015, reality for high yield was much different as gravity kicked in.
This leading indicator thus far in 2016 has also begun to seriously weigh on stocks. From where I sit, while stocks still have plenty further to fall in 2016, high yield in relative terms looks to have reached better reward/risk levels for now and thus may see relative outperformance both in the near and medium-term.
The multiyear chart of the HYG ETF shows that the mean-reversion lower since the 2013 top last week led to a 61.8% Fibonacci retracement of the entire rally from 2009 up to 2013. This area also coincides with horizontal support (blue box). This confluence support zone thus far has held, and last week the HYG ETF left behind strong bullish price reversals both on its weekly and daily charts, thus putting the odds of a material oversold bounce fairly high.
To be clear, this is no “all clear” call on my part to start piling into high yield for the longer-term, but rather what I see is good reward/risk for a good-sized bounce for now.
One step at a time.
On the daily chart note that the HYG ETF last Wednesday, like most risk assets saw material flush-out price action, which by day’s end however closed well off the intraday lows. Last Friday this wash-out selling was followed by an up-gap and rally, pushing the ETF back above its blue 8-day moving average.
Note also that the stochastic oscillator at the bottom of the chart made a higher low last week versus the December lows.
The HYG ETF now faces immediate term resistance around the $79 area but if this is overcome room quickly opens up toward the $81 area. Either way, active investors and traders should use last week’s lows near $76 as a last-resort stop on a daily closing basis.
Like what you see? Sign up for our daily Beat the Bell e-letter and get Serge’s investment advice delivered to your inbox every morning!
You can also download Serge’s 6 Keys for Successful Trading and Investing.
