Those of you who follow our Friday missives know that we often look to the performance of ‘Junk’ bonds (high yield bonds if you prefer) for clues on the health of the US stocks. A healthy junk bond market typically means that there’s enough liquidity in the markets for stocks to ALSO perform well. A quick aside: in apparent contrast to the derisive name ‘Junk’ bonds are somewhat unfairly pigeonholed. In the larger scheme of things, these bonds are anything but junk.

Bond rating agencies rank this class of bond as being below ‘investment grade’ because the risk factor is generally higher than other types of bonds. However, these corporate bonds are, over time, less risky than the broad stock market indexes. Here’s why (source: SeekingAlpha):

In a company’s capital structure, bondholders are senior claimants to shareholders. In the event of bankruptcy and liquidation, bondholders will receive the recovery value of the firm’s assets first. Shareholders are the owners of the firm, and benefit directly from the capital appreciation in the value of the firm. Bondholders are backed by the company’s obligation to pay contracted interest on the amount of principal that they have lent and to receive that principal amount at maturity.

I mentioned a week or two ago that I was feeling encouraged by the happy mood in the junk markets. And their performance has continued and strengthened. Have a look at their chart:

Although the chart has been pretty ugly this year, we saw a ray of hope about July 20. On this day, the JNK markets appear to have stopped going down — for one day. And then, on the next day the JNK market started going UP — a sight for sore eyes! Remember that on these GONOGO charts, a light blue is an UP-trending market. And a few days later the daily bars turned dark blue: indicating a strongly up trending market. We have been pleased. Furthermore, this upward trend appears to be moving into stocks as well!  Have a quick look at this chart of SPY, an ETF representation of the US stock market here:

You’ll note that about the same time, the S&P Index* chart looked similar to that of the JNK chart. SPY didn’t start out quite as strong, but it DID move toward an uptrend. The trend faltered a bit — with the brown bar showing an indecisive market. But then the uptrend continued, and for the past six days we see blue bars (and blue skies!)  The trend is strongly UP.  As always, technical charts don’t tell us how LONG a trend will last, or how far Up it will go, but for now we’re comfortable that our stepping into equities is the right place to be for now. We know that Ms. Market can (and often does) change her mind at any time, and there certainly are plenty of areas of concern that could affect our markets, but our fingers are crossed that this trend will continue.

Ron’s Market Minute – Speaking of Bonds

As some of our readers have pointed out, there have been a number of articles in the media recently that have pointed out the fact that this first half-year has been the WORST start for the US bond market since the late 1700’s! And this has caused much gnashing of teeth because the bond market is typically where investors go to reduce drawdowns when stocks are ailing. I think most investors have a mind-set that bonds are ALWAYS a safety net, but one should tread carefully about such absolutes. We have treaded very lightly this year so far on our bond allocations for investors, and fortunately we have avoided some of the bond drawdowns. Because we have paid a lot of attention to the health of the US bond market, we are pleased to produce yet another chart: this one of the ETF ‘BOND’ which represents a pretty good proxy for the bond market. 

Over the long haul, bonds have had a tailwind at their back. For about 40 years, as interest rates have trended down, bond prices have gone up. It was a double win as there was SOME reasonable interest paid on bonds for most of that time, AND as the interest rates moved down, the bond prices went up! It seems that it’s hard for people to ignore the data, as this surely didn’t happen during the first half of this year and many investors experienced significant bond losses along with their stock losses. However, have a look at the chart of the general bond market, as represented by the ETF ‘BOND.” Note that it looks a lot like the S&P Index chart above. About the middle of July the bond market made an effort to come out of the tank and, like the SPY chart, it also has progressed, giving us some confidence that bonds (for now) are once again fulfilling their objective of working to diversify against potential losses in the stocks, and perhaps we’ll see a bit more interest paid as well — as the Fed raises interest rates. We have a trend now for about three weeks. We’ll see if it continues.

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite D406A
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk


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