Investor Alert

Feb. 15, 2019, 8:23 a.m. EST

The junk bond market has good things to say about the stock market

Junk bonds, which tend to be a predictor for stocks, are at 52-week highs

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By Ivan Martchev

The fourth-quarter stock-market decline was unusual because it wasn’t predicted by price movement in the high-yield bond market.

It takes 35 years in the trenches of the junk bond market for an investment professional to come up with a one-liner that summarizes the volatility of low-grade debt: “It reads like a bond, but trades like a stock.”

As junk bond spreads were blowing out in January 2016, the price of oil price was collapsing and I sought the advice of a seasoned bond trader on some legacy junk bond positions for a new client. It looked like those low-rated bonds were about to go to high-yield heaven. The bond trader, Mike Lanier, was remarkably calm. Upon kicking the tires on all these legacy bond positions, he uttered this conclusion:

“Junk bonds are priced for a recession, but there is no recession in the U.S. Junk (as a category) should see a pretty good rebound from here if there is no recession this year, and I don’t think there will be.”

There was no recession in 2016, but commodity prices had collapsed because of the dramatic slowdown in the Chinese economy. This is relevant in early 2019, as we have another slowdown in China, the price of oil fell from $77 to $42 during the fourth quarter, and the Trump administration is pushing hard to make a trade deal by the March 1 deadline. So what are junk bonds telling us now?

Junk bonds, and stocks for that matter, have come a long way from the dark days of January 2016, when stocks recorded their worst monthly performance for any January on record. In 2019, we just had the best January performance since 1987, so I thought it would make sense to see how the junk bond market has done, if it has indeed confirmed what we have been seeing in the stock market.

For that purpose, I pulled up a chart of the most liquid and biggest (in market size) junk bond ETF, with assets of $14.8 billion — the iShares iBoxx $ High Yield Corporate Bond ETF /zigman2/quotes/204471305/composite HYG +0.02% .

What did I see? A 52-week high! (see chart .)

“No way,” I thought.

This has to be some technicality, I thought. What about those other junk bond ETFs? I started going down the list of junk bond ETFs with the most assets. (They tend to have the heaviest trading volumes and least tracking errors, which the ETF industry is famous for, so spot-checking how junk bonds are doing with several of the most liquid ones would give me a better picture of the situation in the junk bond market.)

One after the other, they showed 52-week highs. When I got to No. 6 on the list, Pimco 0-5 Year High Yield Corporate Bond Index Fund /zigman2/quotes/205210165/composite HYS +0.15% , there were no 52-week highs yet, but the rebound had made it to $99.07 (as of the time of this writing), while the 52-week high from the fourth quarter of 2018 was $99.23. For all intents and purposes, HYS had also matched its previous high from 2018 (see table ).

What new highs for junk bond ETFs might mean

What does all this mean for the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.72% ? Many retail investors don’t know about the close correlation between the junk bond market and the stock market. While not a guarantee, junk bond ETFs at 52-week highs certainly suggest that stocks are heading to new highs as well.

At the onset of the fourth-quarter sell-off in the stock market, I kept a close eye on junk bond spreads and they were remarkably calm in October, although they did widen more notably in November and December as the wheels came off the wagon in the crude oil market. (A big part of the shale boom in the U.S., now the world’s largest producer of crude oil, is financed with high-yield debt. Falling oil prices mean less cash flows for interest payments, hence low oil prices tend to pressure junk bond spreads.)

Still, what I found remarkable about the fourth-quarter sell-off for stocks was that there was absolutely no warning from the junk bond market. That told me it was not an economic problem that was pressuring the stock market. For more, see “Junk bonds are sending the stock market a reassuring message.”

At the risk of sounding like an old-timer, the stock market tends to go where the economy goes, at least over the longer term, so I am not surprised to see this big rebound in stocks in early 2019. Many of the concerns that were pressuring the stock market — such as the constant Presidential Twitter Attacks on the Federal Reserve chairman, the Fed itself sounding hawkish, and frictions with China — have turned around. I still believe that a trade deal with China will serve as a catalyst for stocks.

If the junk bond market is any indicator, the S&P 500 should make a fresh all-time high in 2019.

Ivan Martchev is an investment strategist with institutional money manager Navellier and Associates.

US : U.S.: NYSE Arca
$ 85.07
+0.02 +0.02%
Volume: 17.48M
Aug. 3, 2020 4:00p
US : U.S.: NYSE Arca
$ 94.10
+0.14 +0.15%
Volume: 156,749
Aug. 3, 2020 4:00p
+23.49 +0.72%
Volume: 2.38B
Aug. 3, 2020 4:54p

Ivan Martchev is an investment strategist with institutional money manager Navellier and Associates. The opinions expressed are his own.

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