Regular readers of our weekly missive will be aware of our occasional references to things that we consider to be pointers or influencers, in other words; investables whose market behavior can be taken as signals to the expected behavior of other investables. A case in point is junk bonds — ticker JNK.
As we have said before the lowly junk bond is underappreciated. This is largely due to taxonomy: it has a bad name because it has a bad name. The name is applied because, within the bond world it is lower than ‘investment grade’. However, it has some qualities that you don’t get with equities. If you hold the junk bonds of a company that fails, you get the keys. That won’t happen if your stock in a company goes upside down.
I titled this piece Canary in the Coalmine because of how junk bonds interact with equities and what one can discern about the equity side by watching this bond group.
Here’s how that works. In an expanding stock market, companies are willing to take on debt in order to make capital expenditures, buy new equipment, hire more personnel, etc. A major source of that cash will come from issuing bonds. So, positive bond activity = expectations of growth for publicly traded companies. However, this can work in an opposite fashion in a contracting market. Let’s go to the charts (courtesy of FastTrack):
The solid red line is the Floating Rate Funds (for a nine-year period). The alternating red/green line is the Floating Funds Rate timed with the 50-Day moving average of the Junk Bond Index.
During the 9-year history of floating rate funds, there have been several significant drawdowns in these low-volatility funds (circled), including the 20% drop in early 2020. There is no corresponding drop in the red-green line. That is because the Junk Bond Index was below its 50-day moving average during each of those drawdown periods. What you see is how JNK is a preview of market changes. What it is predicting is stress forces and that can be interpreted as risk levels.
If this causes you to wonder where the indicator sits today, well…the Junk Bond Index is below its 50-day average. If you’re a boater, you may see this as “Red sky in morning, sailors take warning.” You’d be right.
Ron’s Market Minute – – A MOST Unusual Day
If you happened to pay any attention at all to market numbers yesterday, your idea of ‘what is going on?” may have differed greatly depending on what time of day you observed the numbers. From my own observations, the futures indicated a viciously low opening- with projected numbers indicating a loss of 2% or more at the open. We got that- and it was certainly ugly! I hate to overuse the term of a ‘rollercoaster ride’, but that’s what happened as the day progressed: markets were generating one of the biggest intra-day turnarounds EVER in my memory. The numbers on the Dow Index* had a move from bottom to top yesterday of 5.5%! Almost inconceivable. And did it matter?
As always, there will likely be many pundits offering many reasons for the strange market behavior, but in my mind the reasons are not so clear. Some comments today speculate that computer programs kicked in as the S&P Index* hit a number indicating the markets had given up HALF of the post-Covid rally. Bloomberg guessed that the great buying surge was options hedgers unwinding short positions. Deutsch Bank indicated there was ‘no obvious reason’ other than stretched bears ahead of the CPI numbers. Yesterday at 9:32 AM with the S&P at 3491.58 the markets magically and mysteriously turned. It appears (again, my opinion) that the algorithms community and day traders (en-mass) read the headlines of the USA reaching ‘peak’ inflation for the core CPI and pounced on a potential buying opportunity. After all, how could it be worse?
And so? Before the day ended, many were proclaiming the bottom was, yet once again, in. After all, as we have commented here, the seasonality fits. It is the third year of the presidential cycle, and markets often (certainly not always) tend to sport a bottom during this quarter. But then, much of the buying appeared to happen in the S&P Index*. Advancing stocks beat decliners by fifteen to one! A large number to be sure! However, on the NYSE (which includes many smaller companies) the ratio was only two times the decliners. I would think the numbers would have needed to be much closer to indicate some sort of actual bottom.
My 2 cents: In the face of bad news on the CPI front, markets went up. This is bullish market behavior. But as of mid-morning today, much of the gains from yesterday are disappearing. The market behavior over the coming weeks will be a better indicator of what’s happening (or not happening) but for now, it appears that nothing has changed. The rollercoaster ride was entertaining. However, we remain extremely defensive.
Ronald P. Denk, CFP®
Denk Strategic Wealth Partners
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