Conclusion, Investment Implications, Strategy

This week’s strength in high yield corporate bond prices, confirmed by investor asset flows, is indirectly positive for the US stock market — and supports the likelihood that our 3340 near term target in the benchmarke S&P 500 (SPX) will be met.

Since Jly 6th. we halve been pointing out the divergence between high yield bond prices — specifically the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) — and the S&P 500, identifying it as a potential warning signal for the US stock market.  That divergence appears to have resolved itself as of yesterday, in favor of higher US equity prices.

Chart 1 below plots the S&P 500 (SPX) daily since mid March in the upper panel, with a corresponding chart of the daily total net assets invested in JNK (blue line) and their 21-day moving average (red line) plotted in the lower panel.  Our interest in high yield bond prices is their nearly lockstep positive correlation to one another throughout the past 30 years.  Per the correlation, as goes JNK so is likely to go the US broad market.

Chart 1

The red highlights show that the total net assets invested in JNK were below their 21-day MA from Jun 19 to Jly 20th, indicating a trend of monthly contraction characteristic of near term price declines.  Accordingly, JNK was weak during this period, remaining below its 200-day MA (major trend proxy). Per the correlation, we saw this weakness as a potential canary in the coal mine — for upcoming weakness in the S&P 500. 

However, the green highlights show that as of Jly 21st these assets have spiked back above their 21-day MA, indicating a new trend of monthly expansion — while being corroborated by a rise in JNK above its 200-day MA.  As long as JNK can now remain above its 200-day MA, currently at 104.15, it will indicate an emerging major bullish trend change in the ETF  — and this would support more upcoming US broad market strength.