One of the most reliable indicators we have of the mood of the market is the behaviour of high yield (also known as junk grade) corporate bonds relative to investment grade bonds. We have found, almost without exception, that high yield corporate bonds begin to underperform investment grade bonds well before the stock market turns down. We have also found that stock market rallies do not come to much unless they are accompanied by outperformance of high yield bonds relative to investment grade.
We use the Vanguard High Yield Corporate Bond fund as a proxy for the high yield corporate market. We use the ETF “AGG” as our proxy for the investment grade market. Note, how a strong sell signal was generated in July last year with the relative line falling below the moving average(and perhaps a “weak sell signal before that)…..and a strong buy signal was generated in early April this year. We use a 90 day moving average as our indicator, depending on one’s time frame a longer or shorter moving average could be employed.
If one did not want to trade an open ended fund then there are two high yield corporate bond ETFs available “HYG” and “JNK”. We like JNK. Notice how JNK closed higher yesterday even when the Dow closed down by almost 2% and AGG (less risky investment grade corporate bonds) closed only marginally higher. This is very bullish behaviour. Up until mid March at least whenever the Dow fell JNK followed……now it appears that buyers of Junk grade bonds want nothing to do with the equity bears.
Whilst junk grade corporate bonds continue to do well in their own right and relative to investment grade bonds it is reasonable certainty that there is more upside left in equity markets. We remain bullish equity markets.
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