High-yield bonds are sending the stock market a warning sign.
Yes, the S&P 500 made a new all-time high on Wednesday. Yes, the Fed’s easy money policy is helping to boost stock prices. Yes, President Trump wants a higher stock market. And yes, we are entering a seasonally bullish period for stocks.
And, if high-yield bonds were making new highs along with stocks this week, then I’d have to wipe the bearish egg off my face and concede that the stock market isn’t in as much trouble as I thought.
As we’ve pointed out many times before, the action in high-yield bonds tends to precede the action in the stock market by anywhere from two days to two weeks. So, it’s notable that while the S&P was posting a new all-time high on Wednesday, junk bonds were falling.
And, by the look of the following chart of the iShares iBoxx High Yield Corporate Bond ETF (HYG), junk bonds look vulnerable to a much more serious decline.
Take a look…
This chart is forming a rising wedge pattern with negative divergence on the MACD and CCI momentum indicators. In other words, as HYG has been pushing higher and making higher highs over the past few months, the momentum indicators have been making lower highs.
This pattern usually leads to a breakdown – which means a selloff in the high-yield bond market.
That would be bearish for stocks.
And, if we combine this setup with the recent increase in bullish investor sentiment (a contrary indicator), the complacent level of the Volatility Index (VIX), and the huge price difference in VIX call options over VIX put options…
Then that gives trades plenty of reason to be cautious – or maybe even bearish – on the short-term prospects of the stock market.
Best regards and good trading,
P.S. There’s two ways to react to a bear market.
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