February 12, 2019

It takes 35 years in the trenches of the junk bond market for an investment professional to come up with a one-liner that summarizes the volatility of low-grade debt: “It reads like a bond, but trades like a stock.”

As junk bond spreads were blowing out in January 2016, the oil price was collapsing, and I sought the advice of a seasoned bond trader on some legacy junk bond positions for a new client. It looked like those low-rated bonds were about to go to high-yield heaven. The bond trader, Mike Lanier, was remarkably calm. Upon kicking the tires on all these legacy bond positions, he uttered this conclusion:

“Junk bonds are priced for a recession, but there is no recession in the U.S. Junk (as a category) should see a pretty good rebound from here, if there is no recession this year, and I don’t think there will be.”

There was no recession in 2016, but the prices of commodities had collapsed because of the dramatic slowdown in the Chinese economy. This is relevant in early 2019, as we have another dramatic slowdown in China, the price of oil fell from $77 to $42 in the fourth quarter of 2018, and the Trump administration is pushing hard to make a trade deal by the March 1 deadline. So, what are junk bonds telling us now?

Junk bonds, and stocks for that matter, have come a long way back from the dark days of January 2016, when stocks recorded their worst monthly performance for any January on record. In 2019, we just had the best January performance since 1987, so I thought it would make sense to see how the junk bond market has done, if it indeed confirmed what we have been seeing in the stock market.

For that purpose, I pulled up a chart of the most liquid and biggest (in market size) junk bond ETF, with assets of $14.8 billion the iShares iBoxx $ High Yield Corporate Bond ETF (HYG).

What did I see? A 52-week high!

“No way,” I thought.

This has to be some technicality, I thought. What about those other junk bond ETFs? I started going down the list of junk bond ETFs with the most assets. (They tend to have the heaviest trading volumes and least tracking errors, which the ETF industry is famous for, so spot-checking how junk bonds are doing with several of the most liquid ones would give me a better picture of the situation in the junk bond market.)

One after the other, they showed 52-week highs. When I got to #6 on the list, PIMCO 0-5 Year High Yield Corporate Bond Index Fund (HYS), there were no 52-week highs yet, but the rebound had made it to $99.07 (as of the time of this writing), while the 52-week high from 4Q 2018 was $99.23. For all intents and purposes, HYS had also matched its previous high from 2018.

New 52-Week Highs for Junk Bonds Likely Mean New 52-Week Highs for Stocks

What does all this mean for the S&P 500? Many retail investors do not know that there is a close correlation between the junk bond market and the stock market. While not a guarantee, junk bond ETFs at 52-week highs certainly suggest that stocks are going to new highs, too.

At the onset of the 4Q sell-off in the stock market, I kept a close eye on junk bond spreads and they were remarkably calm in the month of October, although they did widen more notably in November and December as the wheels came off the wagon in the crude oil market. (A big part of the shale boom in the U.S., now the world’s largest producer of crude oil, is financed with high-yield debt. Falling oil prices mean less cash flows for junk bond coupons, hence low oil prices tend to pressure junk bond spreads).

Still, what I found remarkable for the 4Q sell-off in stocks in 2018 is that there was absolutely no warning from the junk bond market. Unlike many prior sell-offs in stocks where junk bonds led the stock market, this time they lagged. That told me it was not an economic problem that was pressuring the stock market.

At the risk of sounding like an old timer, the stock market tends to go where the economy goes, at least over the longer term, so I am not surprised to see this big rebound in stocks in early 2019. Many of the issues that were pressuring the stock market – such as the constant Presidential Twitter attacks on the Fed Chairman, the Fed itself sounding hawkish, and frictions with China – have turned around of late. I still believe that a trade deal with China will serve as a catalyst for the S&P 500 to retest its all-time highs.

If the junk bond market is any indicator, the S&P 500 should make a fresh all-time high in 2019.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

About The Author

Ivan Martchev
INVESTMENT STRATEGIST

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. *All content of “Global Mail” represents the opinion of Ivan Martchev*

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