High yield debt has taken a hard break to the downside and that supports the prediction that a pullback in markets is coming. Usually when a strong break either up or down occurs on the chart of HYG, the stock market follows within a 3 – 5 days. Using the high yield debt bond market as a leading indicator for short term swing trading is something you should be doing if you aren't already.
High Yield Debt Chart
The hard break down in HYG is indicative of a market pullback. The move lower seems a bit ahead of the September 25 – September 29th market pullback that I predict is coming. We could see HYG chop out a little before continuing the plunge lower as drawn on the chart above.
The goal is to get out of the way of a market pullback, and then go long once the stock market reverses. Since September is the worst month of the year for stocks, you have to be careful to not chase anything higher. Ideally you want to look for oversold stocks to go long as the market pulls back. I did a stock trading lesson on oversold patterns here.
Following high yield debt is an excellent way to time market swings. A high yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade. These bonds have a higher risk of default and so they pay a higher yield than better quality bonds. Bonds rated below BBB− are called speculative grade bonds, or “junk” bonds, and fall into the category of high yield debt.
Recessions increase the possibility of default in speculative-grade bonds.
The number of companies issuing high yield debt is abnormally high for August. What is happening is that investors are anticipating higher rates from the Federal Reserve and so the higher yields of safer investment grade bonds start to come into greater competition with junk bonds. It's the crowding out effect.
Tesla and other debt heavy corporations are front-running the crowding out effect by issuing as much junk bonds as they can before more interest rate hikes occur. You can read about rising junk bond issuance here.
You have to be careful not to equate junk bonds in foreign countries with those issued in the US. In emerging markets like China and Vietnam, bonds have become increasingly important as financing options because access to traditional bank credits is limited, especially if borrowers are non-state corporations.
High Yield Debt Chart
Junk bonds act as a barometer for risk on versus risk off. In a risk on environment, investors chase after maximum yield and so they buy high yield debt. Junk bond investors are not too worried about a recession or default on their junk bonds. In a risk off environment, investors sell out of high yield debt and move to safer, lower yielding assets.
When non-investment-grade bonds spike up or down, the S&P 500 has a tendency to follow within 3 to 5 days.
Last week the high yield debt chart (HYG) spiked higher which is a bullish signal for the S&P 500 over the next 3 to 5 day period.
Watch out for investing in high yield corporate debt. U.S. default rates are surging higher and breaking away from the rest of the world.
The U.S. has more oil and gas firms that are financed by the high yield bond market than anywhere else on the planet. The S&P calls these oil and gas companies the “weakest links.”
Accommodative Federal Reserve policy (ultra-low interest rates and lower lending standards) caused a lot of borrowing by smaller oil and gas companies profiting from the shale oil boom. When the price of oil crashed, S&P downgraded the credit rating on lots of that debt to B- and lower.
Now you see why many oil and gas executives are using the mainstream financial media to disseminate fantastic stories of oil production cuts by OPEC members. The goal is to jawbone the price of oil higher. No one is going to cut production when oil prices are this low because they have to produce more to make up for the budget shortfalls caused by the lower price of oil. Remember the law of man: when things get bad enough, it's every man/country for himself.