Junk Bonds Don’t Confirm Higher Highs

By Tom McClellan

Junk bonds are not confirming the S&P 500’s higher highs

Junk bonds (HIO) vs SP500
May 26, 2017

The SP500 has rebounded from the May 17 one-day panic to push to a higher high.  But high-yield bond ETFs like HIO are not confirming that higher high, and that’s a problem.

High yield bonds typically move in sync with the stock market rather than with T-Bonds.  They are all about liquidity and default risk, much more so than inflation and other interest rates.  So when liquidity starts to dry up, that condition often shows up first in the high-yield bond market.  Eventually those liquidity problems come around to bite the rest of the stock market.  So it is important to pay attention to these divergences.

Sometimes the divergences are bullish, as we saw when HIO made a pattern of higher highs in March and April 2017 while the SP500 was making lower highs.  That foretold the stock market strength which eventually materialized.

The message does not always work, though.  Right after the November 2016 elections, it got a bit screwy.  Lots of things were screwy then.  So don’t assume that it is always perfect.  The same point applies for all technical analysis techniques and “rules”.

Right now, this divergence between HIO and the SP500 fits well with my expectation for a 2-3 week dip into a low due in June 2017, which should be followed by a strong new uptrend.  Such a selloff could serve the useful purpose of scaring out the weak hands.

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