Are Junk Bonds Signaling Pause in Equity Rally?

Are Junk Bonds Signaling Pause in Equity Rally?

What does the bond market know that the stock market doesn’t?

Even the U.S. stocks (NYSEARCA:IWV) have been scoring one record high after another, the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK) has gone in the opposite direction.

The performance divergence between high yield bonds (also known as “junk bonds) (NYSEARCA:HYG) and the S&P 500 (SNP:^GSPC) began on May 22 and has grown. Since then, SPY has gained almost 6% while JNK has declined 1.18%.

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Although market divergences can last for extended periods, they never last indefinitely.

SPY vs. JNK

Junk bond prices tend to mimic the broader stock market (NasdaqGM:QQQ) because equity prices correlate with the risk of companies defaulting on their debt. Both asset classes have a similar risk profile and the historical correlation or pattern between the two is high.

During the 2008 bear market, JNK declined 25.67% while SPY fell 36.81%. But even before the onset of the equity meltdown (NYSEARCA:DIA), the high yield bond market was the canary in the coal mine.

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