High Yield Corporate Bonds as indicator for Risk Appetite
This is not something I would use as a trading signal by itself, but it is a good indicator on the weekly chart of how bigger players are viewing risk appetite.
High yield corporate bonds, as seen reflected in ETFs like
HYG
and
JNK
, are an interest data point. High yield implies that these are riskier bonds with a higher chance of default on the debts. Just like as individuals, we have credit scores and when we apply for loans, the interest rate can vary depending on how the bank rates us risk-wise on perceived ability to pay back the debt, those who have a lower score might get a higher interest loan because they are considered higher risk of default. Same basic principle applies to corporate debt.
When liquidity is flowing and the economy overall looks good, large investors/investment banks will feel better about buying riskier high-yield bonds and other debts because we're in an economy paradigm where there's a better chance that not enough of those will default to cause significant harm to the debt holders.
But, when the economy is getting pinched for whatever reason and liquidity starts to dry up, high risk, high yield debts are much less desired due to perceived increased risk of default.
Sometimes the high yield debt moves pretty close in tandem with the market, see for example the dumping that happened during the 2020 COVID panic.
Before and after that, you can often see a bearish divergence in
HYG
and
JNK
many weeks before the S&P finally tops out and begins its decline. The above chart, you can see the decline become more obvious as we wind down 2017 and head into 2018, then also see it again pretty obviously in the second half of 2021 before the sell off for most of 2022 started.
Both
HYG
and
JNK
came online around 2007-8 timeframe, just before the GFC. You can see a pretty steady decline right from the beginning there, and a rapid rebound as things find bottom.
What is interesting is how far both
HYG
and
JNK
came down throughout 2022, and while equities have since had a nice recovery bounce for most of 2023, the high yield bonds have not had such a recovery. It's actually instead slowly condensing price action with slightly higher lows, but also lower highs. We seem to be nearing the end of that wedge and hopefully soon we get an answer on what the risk appetite really is of risky debt, because it will be a solid signal of where equities may be headed next.
Personally, I'm already seeing some indications that as we approach the end of the year, we may see a larger dip in equities. For how long and how large, that remains to be seen. For right now, we're having a recovery rally from selling off most of August and I'm not seeing any indication it's a good time to go against that trend, but that may change in the coming weeks.
High yield corporate bonds, as seen reflected in ETFs like
HYG
and
JNK
, are an interest data point. High yield implies that these are riskier bonds with a higher chance of default on the debts. Just like as individuals, we have credit scores and when we apply for loans, the interest rate can vary depending on how the bank rates us risk-wise on perceived ability to pay back the debt, those who have a lower score might get a higher interest loan because they are considered higher risk of default. Same basic principle applies to corporate debt.
When liquidity is flowing and the economy overall looks good, large investors/investment banks will feel better about buying riskier high-yield bonds and other debts because we're in an economy paradigm where there's a better chance that not enough of those will default to cause significant harm to the debt holders.
But, when the economy is getting pinched for whatever reason and liquidity starts to dry up, high risk, high yield debts are much less desired due to perceived increased risk of default.
Sometimes the high yield debt moves pretty close in tandem with the market, see for example the dumping that happened during the 2020 COVID panic.
Before and after that, you can often see a bearish divergence in
HYG
and
JNK
many weeks before the S&P finally tops out and begins its decline. The above chart, you can see the decline become more obvious as we wind down 2017 and head into 2018, then also see it again pretty obviously in the second half of 2021 before the sell off for most of 2022 started. Both
HYG
and
JNK
came online around 2007-8 timeframe, just before the GFC. You can see a pretty steady decline right from the beginning there, and a rapid rebound as things find bottom. What is interesting is how far both
HYG
and
JNK
came down throughout 2022, and while equities have since had a nice recovery bounce for most of 2023, the high yield bonds have not had such a recovery. It's actually instead slowly condensing price action with slightly higher lows, but also lower highs. We seem to be nearing the end of that wedge and hopefully soon we get an answer on what the risk appetite really is of risky debt, because it will be a solid signal of where equities may be headed next.
Personally, I'm already seeing some indications that as we approach the end of the year, we may see a larger dip in equities. For how long and how large, that remains to be seen. For right now, we're having a recovery rally from selling off most of August and I'm not seeing any indication it's a good time to go against that trend, but that may change in the coming weeks.
Comment:
Zoomed in on just
JNK
by itself, new wedge drawn on the daily chart, as of today, these corporate high yield bond ETFs have broken down below the lower trend line of the wedge. Yet another warning shot that we are headed back to risk-off.
We can add to this the two successive higher lows on VIX divided by VVIX on the weekly chart:
That isn't to say I don't think we rally higher from here. Short term, I think we can rally back some. However, as we get later in Q4, I suspect we will start seeing more and more obvious signs that yes, the bulls are no longer super bullish and selling is going to take over.
This is just another warning shot, but not quite yet full on liquidation mode. But we are certainly inching closer. It's time to sharpen focus and be on the lookout for more signs that we are likely headed for a very rough next 6 months to a year for equities and start positioning accordingly.
JNK
by itself, new wedge drawn on the daily chart, as of today, these corporate high yield bond ETFs have broken down below the lower trend line of the wedge. Yet another warning shot that we are headed back to risk-off.
We can add to this the two successive higher lows on VIX divided by VVIX on the weekly chart:
That isn't to say I don't think we rally higher from here. Short term, I think we can rally back some. However, as we get later in Q4, I suspect we will start seeing more and more obvious signs that yes, the bulls are no longer super bullish and selling is going to take over.
This is just another warning shot, but not quite yet full on liquidation mode. But we are certainly inching closer. It's time to sharpen focus and be on the lookout for more signs that we are likely headed for a very rough next 6 months to a year for equities and start positioning accordingly.
Comment:
The junk corporate bonds did indeed break down out of that wedge, providing us with a solid bear warning for the larger market. The market itself has obviously been sliding since August, has not had a decent rally back yet.
The junk bonds have found a resting spot for the moment, it seems. Maybe we're getting a bottoming signal for the current bearish moment and we get a holiday rally before the market really starts to get hammered by bears in a much bigger way heading into next year.
The junk bonds have found a resting spot for the moment, it seems. Maybe we're getting a bottoming signal for the current bearish moment and we get a holiday rally before the market really starts to get hammered by bears in a much bigger way heading into next year.
This just can give some advanced warning before the market tops that the big money is starting to pull back from risk, just adding yet another warning sign to look out for prior to large corrections.