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The Market's Measure
market's measure

Junk Bonds Pick A Happy Tune For Stocks

More upside predicted by an ETF’s downside

Earl Scruggs’ “Foggy Mountain Breakdown” is a bluegrass tune that every banjo picker—including Steve Martin – aims to master.

A different sort of breakdown, though, has enlivened traders this week. The ProShares Short High Yield ETF (NYSE Arca: SJB) fell through a double bottom on Thursday, setting the stage for another down leg on its long-term chart. SJB provides unlevered inverse (-1x) exposure to the Markit iBoxx $ Liquid Yield Index, a market-weighted index of corporate high-yield bonds with maturities between 3 and 15 years. If you want to bet against junk bonds, SJB lets you do so for just 89 basis points (0.89 percent) a year.

Even if you don’t want to short the junk market, SJB is still worthy of your consideration if for nothing else than as a bellwether of the stock market’s health.

You can see why in the chart below. When SJB goes up, equities – proxied by the SPDR S&P 500 ETF (NYSE Arca: SPY) – go down. Perhaps it’s better to say it this way: When SJB tumbles, SPY goes up. Why niggle over semantics? Because SJB’s the leading indicator. SJB prices move just a step ahead of SPY’s. You see, the short junk ETF is exquisitely sensitive to behind-the-scenes troubles on corporate balance sheets. Wobbles in SJB’s price are “tells” for stock punters.

All this arises because of junk bonds’ close relationship to common stock. Both asset classes have low priority claims to corporate earnings and liquidation proceeds. The bond side just tends to respond first.

In essence, SJB’s trend portrays the default risk at the dodgy end of the bond market, in contrast to investor zeal for the blue chip stocks in the S&P 500.

So, after a dramatic post-election runup in stock prices, traders are now pondering the prospects for further equity market advances. The SPY chart reflects this. It looks a little ragged now. But look at SJB’s trajectory. A pretty clean downtrend line, no?

Pretty clean, yes. In fact, SJB’s chart seems to indicate there’s room for another 17 percent loss. That, in turn, translates to a potential 12 percent advance for SPY.

Earl Scruggs used to say: “I don't think you'll ever get enough picking.” And now, junk bonds seem to have picked an upward path for stocks.

Brad Zigler is REP./WealthManagement's Alternative Investments Editor. Previously, he was the head of Marketing, Research and Education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds.

TAGS: Fixed Income
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