Junk Bonds Point To A Possible Bounce In US Equities

Intermarket analysis is all about correlations and understanding how one asset class’s performance can impact other markets or asset classes. When it comes to analyzing the US stock market, we like to look at it in conjunction with the US bond market, some select commodities, the VIX and the US dollar.

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After looking into Silver price’s performance and the Nasdaq volatility index in previous articles, today we cover high yield bonds. These bonds, otherwise known as junk bonds, are considered a strong risk-on indicator. When they roll over, liquidity will likely dry in the stock market. The chart below shows exactly that.

The interesting part however, is this important risk-on indicator is now in a support area. This leads us to believe that a relief rally in the US stock market could happen very soon. It could also point towards a reversal in the current downtrend but it’s too early to draw such a conclusion.

Junk bonds trading in a support area, how does this impact the SPX?

If we consider junk bonds a leading indicator and look specifically at what happened to $SPX when junk bonds bottomed previously, we see the following: Bonds bottomed, the $SPX lagged then caught up quickly to rising bonds. So if junk bonds reverse to the upside in this 92 to 94 area, the $SPX will bounce in the 3500 to 3700 area. A bottom also could be set at those levels.

A quick look a the yields chart also confirms that we might see a trend reversal here: Yields reached a strong resistance area from 2018. It is very likely that they made a top but we remain cautious as there is also that support level very close by. So really the confirmation comes once the support or resistance break. That’s when the new trend (or continuation) will be clear and confirmed. And that’s exactly what we will be watching for.

 

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