Is junk giving a bad signal for the market?
Low grade, high-yield corporate bonds—affectionately called “junk bonds”—are on track for their worst month in nearly a year. Investors junked their junk bond funds to the tune of $4.8 billion last week, according to a report by Bank of America Merrill Lynch.
Junk bonds tend to trade closely with stocks. That’s because junk bond prices are closely tied to companies’ ability to repay the debt which, like stocks, depends on the fortunes of the company.
Gina Sanchez, founder of Chantico Global, believes junk bonds are good indicator for stocks.
“When you go down the capital structure, junk bonds are just a tad above stocks in terms of where they stand,” said Sanchez, a CNBC contributor. “Because they are so low in the capital structure, and because their quality tends to be so low, then you would expect that there should be a relationship.”
Sanchez said investors should pay attention to the spreads between junk bonds and higher-grade debt. “Spreads have gotten so tight in high yield,” she said. “Investors now are sitting up and saying ‘you know, I really think I need to be paid more for the risk that I’m buying.’”
Ari Wald, head of technical analysis at Oppenheimer & Co., also sees junk bonds as a signal for the markets, but just for the short run.
“In the near term, we are also seeing some indications of fatigue that would support that view that these junk bonds are selling off and maybe equities are next,” Wald said. “Looking back since June, there have been fewer stocks making three-month highs. So that’s a little bit of a near-term concern. I think consolidation would be very healthy here.”
Wald thinks it’s reasonable to expect a 5 percent pullback soon because there have been four such declines of that magnitude over the last 12 months.
“It would be very good for this uptrend,” said Wald, who sees support around the 1,900 to 1,925 level should a decline take place. “But make no mistake: We think this bull’s intact and you’re going to be finding buyers on that pullback.”
To see the full discussion on the S&P 500, with Sanchez on the fundamentals and Wald on the technicals, watch the above video.