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.
The sell-off in technology is more about market reversion to the mean than it is indicative of some gloom and doom scenario where technology stocks lead the rest of the market lower.
Credit Suisse just released a report to clients where they are neutral to slightly cautious on technology stocks for the next 3 months, but remain positive longer out.
There are many bottoms-up drivers in the technology sector right now including the new iPhone, continued increase in cloud usage, greater adoption of artificial intelligence across various sectors, and autonomous driving. Technology adoption and market penetration are likely to increase over the next couple of years.
The S&P 500 is dominated by a few big tech companies. Innovations such as more automation in the grocery industry from Amazon, the iPhone 8, and Tesla’s Model 3 are catalysts for the S&P 500 to move even higher.
Reversion To The Mean
The green line is what I would calculate the mean to be at. As you can see, QQQ has overshot the mean over the last few months and so a move back towards the 10 year mean line is normal.
Fiscal policy will also be a catalyst for continued growth such as tax reform. The medical device tax, investment tax, tanning tax, Medicare Hospital Insurance surtax, the health insurance fee and tax on brand pharmaceutical manufacturers, all will likely be repealed at some point in the future.
Credit Suisse set negative expectations for consumer goods. Stocks that trade in the consumer goods sector are likely going to be stocks we should avoid. Fundamentals and valuation are likely to continue to deteriorate in clothing, department stores, grocery, and packaged food.