Junk Bonds Confirm New Highs In Stocks

Last week we noted the often accurate Sell warning given by the negative divergence of High Yield “Junk” Bonds vs the stock market. Stocks did quickly plunge a few hundred points on the Dow into early April as the Oil price rally stalled. Since then Oil has resumed its assault on new highs with a $7/barrel surge leading Junk Bonds to break out to new 4 month highs and reduce credit fears. As most are aware, High Yield Bonds are heavily influenced by the credit risk associated with the rise and fall of Oil prices. The forecast for a February low and rally into the April/May has already occurred and is good news for stocks as well as the global economy. 

Junk bond divergence 4-2016

Oil is heating up this week due in part to the anticipated meeting in  Doha, Qatar between 20 major oil producing countries. While most nations are willing to cut production, if it means higher prices, we doubt meaningful action can be taken other than promises as we know that Iran must increase production and the Saudis certainly don’t want prices rising too far too fast. Prices above $50 will allow the US shale fracking wave to gain ground and prolong OPEC’s market share woes.  The markets will determine the magical trading range required to keep shrinking US production, but avoid the continued financial collapse in the Middle East, Venezuela and Russia. We suspect Oil prices will top out this week – short term – as Bullish production cut expectations are negated next week. There is still potential for higher energy prices as the global economy bounces back in the 2nd quarter and seasonal inventory drawdowns. As we have said many times, Oil prices are an important barometer for the economy, earnings and the stock market. Oil above $40 is good news for stock prices, while Oil below $30 would be very bad news on many fronts. With Oil inventories moving into contraction mode for the next 4 months and the economy rebounding from anemic 1st quarter growth, the risk of testing $30 and below is slim.

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