After seven quarters of choppy financial markets where risk assets such as equities haven’t shown much positive performance (if any), more investors are taking notice. To wit, the high yield complex as represented by the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) has largely trotted sideways over the past couple of years. It’s increasingly tracing out a concerning pattern that ultimately could result in plenty of downside.
HYG represents a basket of high-yielding (i.e. lower credit rating) corporate bonds. Although corporate credit spreads have not yet deteriorated much in this late cyclical environment, they did recently start to widen somewhat. If the economy continues to slow, then these high-yield bonds should start to fall, along with the HYG ETF.
Looking at both sides, note that the bulls point to the fact that although companies carry lots of debt on their books, the interest they pay on this debt is low. Thus the bulls argue that the HYG ETF could stay aloft. The bears point to the fact that ultimately every economic expansion cools off and corporate credit spreads begin to widen.
Moving from credit markets talk, let’s look at what the charts have to say.
HYG Stock Charts
On the multi-year chart we see that the HYG ETF over the past few years has continually narrowed its trading range. The well-defined series of lower highs and higher lows will ultimately lead this ETF to break in one direction or another. The question is: when will this occur?
Given my the aforementioned points, personally I think the direction ultimately points lower for HYG and possibly back to the lower end of the narrowing range that I marked with the two red lines.
On the daily chart we see that one way to draw the lines on the year-to-date price action on HYG is by tracing out a head and shoulders pattern (red arches), which tends to resolve to the downside. Also note that the lower end of said pattern currently coincides with the red 200-day simple moving average. This is a well-defined line in the sand, and if and when the HYG ETF breaks below there it has plenty of further downside.
Active investors and traders expecting HYG to break lower could short the ETF around the $86 mark with a next downside target around $84.
The highest probability trade that sets up well for this set up in HYG is to sell an out of the money call spread (options credit spread) in a very specific way. I am hosting a special webinar Friday Oct. 11th to go over this setup in detail. Register here.
Special free webinar: How to generate stock market income with options credit spreads like a pro. Register HERE