There have been many themes throughout this market recovery, now
in its fifth year. The Fed's ever present invisible hand,
interest rates that remain near historical lows, and an investor
persistently searching for higher yields are just a handful of the
many mega themes that have shaped these markets. However,
with most things in life there are usually unintended consequences,
both good and bad. One of these unintended consequences is
the extreme correlation now among most major asset classes.
This in and of itself creates a greater challenge in obtaining a
"diversified" portfolio which I touched on in an article entitled "
Are Rising Correlations a Threat to Your
Some examples of this increased correlation border on absurd
such as the now much higher correlation between European
(NYSEARCA:VGK) and American equity markets (NYSEARCA:IWM) or the
significant connection between oil prices (NYSEARCA:DBO) and equity
In a few instances, though, such high correlations make more
sense. The high yield debt (NYSEARCA:HYG) market is one such
example, actually helping us make more informed investment
Junk vs. Equity
Rightly so, high yield debt, also referred to as speculative
grade or junk bonds, is very similar to its equity
counterpart. Junk bonds (NYSEARCA:JNK) are the riskiest and
generally the last of the debt tranches to get paid during any sort
of liquidation, the final rung before equity holders. As the
last tranche of debt, their bond payments are also the last
interest service paid, just before equity dividends, so generally
the risks between the two are similar compared to other corporate
All of these similarities show up in a very high rolling
correlation between equity markets (NYSEARCA:DIA) and high yield
bonds. When the equity markets are up, typically so are junk
bonds. When junk bonds are down, typically so are
Given the fundamental similarities and high correlation between
the high yield and equity markets, it makes sense to notice when
these two markets are not behaving similarly, and currently JNK is
not confirming the S&P's new price highs.
Is Junk Blessing Us?
Knowing that two markets are highly correlated means we can
follow both those markets and see when one is not behaving as
expected. Knowing that these two markets should be much
correlated allows us even more comfort in that expectation, icing
on the cake, so to speak.
Looking at the chart below, JNK thus far has not made a new high
above its May levels. Meanwhile most equity markets have and
that is important.
Given the long term history of the two markets and the fact that
they eventually always confirm one another, a high probability
trade opportunity presents itself.
Buying JNK with the expectation it should do as it always has,
and confirm the S&P's new high in price is thus the play
here. The target would be a new JNK (NYSEARCA:JNK) high above
$41 as detailed in our latest Profit Strategy Newsletter.
Is Junk Cursing Us?
However, the fact that JNK has not made a new high yet, after
five months and after two more new highs in the S&P (SNP:^GPSC)
is troublesome. Could junk actually be warning us?
An old saying on Wall Street is, "the bond market (NYEARCA:BOND)
is smarter than the stock market (NYSEARCA:VTI)". There are a
few reasons for this, but generally it's because the bond
market is so much larger and with much less retail (i.e.
dumb money) influence.
The fact that junk bonds are not leading equities higher
here needs to be noticed as a similar setup with volatility warned
us of the September price highs as we outlined in our article,
"Calm Q4 Ahead for Stocks?"
Our subscribers were able to take advantage of a similar
divergence between two highly correlated markets when we suggested
buying VIX call options in our
that resulted in a 30% gain in just two weeks.
In our latest ETF Profit Strategy Newsletter we laid out a few
ways to play the latest setup, this time with JNK. However,
the JNK long position needs to be watched closely. If certain
price levels we are watching breakdown, it will be a sign that this
market top indeed is different than the previous ones as the
non-confirmation by JNK warns of another top.
Junk has been warning us since the May highs, but will it
finally bless this market's new all time high with its own high, or
will it again curse this market's rally like it did in August and
Profit Strategy Newsletter
uses technical, sentiment, and fundamental analysis to stay ahead
of the market's trends. For the first time since the five
year rally began, high yield debt has not confirmed the equity
markets new high, and this offers opportunity.
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