Warning from High Yield Bonds

The S&P500 kept the party going last week. The index managed to rise another percent on even lower weekly volume. Volatility dipped slightly, but notably, it hasn’t returned to the ultra-complacent levels seen during the summer months when the S&P itself traded at lower levels. So while the overall index is at all-time highs right now, many investors are a bit more nervous about whether these highs can be maintained.

The technicals point to a US stock market that’s over-stretched. Actually, it’s ridiculously over-stretched….with the S&P500 climbing from its mid-October lows without dropping below its 5 day moving average since that time. This is a very unusual pattern for stocks to follow, even for stock markets in traditional bull markets.

The US economic releases, last week, painted the typical unimpressive picture. Industrial production disappointed. So did housing starts. Initial jobless claims came in worse than expected. PMI manufacturing and the Empire State manufacturing survey both missed expectations. At the same time, the Philly Fed beat consensus estimates. Existing home sales climbed at bit and leading indicators (pumped up directly by the rising stock market) also beat expectations. All in all, there is still no organic, self-sustaining economic recovery for much of America–specifically for Main Street Americans.

While US stock markets set new record highs last week, an interesting divergence was logged in the high yield credit markets. For the first time since the near 20% sell-off in the S&P in 2011, the junk (or high yield) market—as measured by the HYG ETF—registered a negative divergence.  Its 50 day moving average crossed below its 200 day moving average.

When this last happened in mid-2011, the S&P500 went on to lose almost 20%….but only after this event happened in HYG.  This suggests that the smarter money was in high yield bonds and that it led the general equity markets by dropping before the stock markets corrected.

So if the something similar were to happen this time, then now is the time to lighten up on your equity positions. While this credit market did lead the equity markets, the lag time was minimal.

So the alarm bell is going off right now.  High yield money is scared and stock market investors should take note.

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