Junk Bonds Stall Stock Market Run to New Highs

Fear Fades

One of the Buy signal indicators shown in our late August report displayed the CNN Fear & Greed Index. ( https://execspec.net/oversold-extremes-october-low-china-stocks-oil/ ) From late August through September the Fear gage fell to an extreme reading after a 16% stock market correction – the 2nd largest price decline since this Bull market began in 2009. We noted that there were many indicators reaching multi-year extreme oversold inflection points for investors in August/September.

Major indices are testing their all time record highs again. With the Nasdaq, led by Facebook, hitting new record highs this week and other averages chomping at the bit to catch up, it will be interesting to observe how long the fear of higher interest rates based upon the stellar jobs report today will be able to keep a lid on stocks. Sentiment is neutral and stocks are holding most of their gains despite new expectations this week of higher interest rates. It seems only a run to new lows in Oil prices can impede the stock markets run for the roses.  We expect any minor correction should be bought into year end.

Fear & Greed Nov 2015

Junk Weighs on Stocks

Our last report presented stock market correlations with Junk Bond prices. As Junk Bond prices rise the perceived risk and corresponding interest rate or yield decline – as with all Bonds. In a healthy market Junk Bond prices will rise (becoming less risky) in unison with the stock market on increasing optimism. The High Yield Junk Bond Index has offered very timely negative divergence points over the summer for selling near record highs prior to the 16% August swoon. In recent days new negative divergences have suddenly appeared. As before this divergence is due to stocks rising while Oil prices (key value factor in Junk Bonds) fall. The concern for Bond holders is that marginal US shale oil producers will increasingly default on their debts.

Junk Bond vs SP 11-2015

A closer look at the same chart below illustrates the recent negative divergence over the past week that should push stocks lower until the Oil market turns back up. Lower Oil prices send a signal to the market that the economy is weak and energy demand can’t overcome the oil production glut. With the very strong employment report today the stock market has the additional weight of a much higher odds Fed rate hike in mid-December.

DIA vs junk bonds

Since 2014 Junk Bond price weakness (rising risk yields)  occurs primarily due to the action of Oil and the energy markets. With the explosion of risky shale producers since 2011 pushing US output up at a parabolic rate, the ensuing inventory surplus and Oil price collapse since 2014 has pushed more marginal producers toward bond defaults. Thus as Oil goes, so goes Junk Bonds, so go stock indices – for the most part.

Oil vs SP 11-2015With the weakness of the Japanese Yen supporting fund flows into stocks we suspect Oil prices will need to keep falling in order for US stocks to correct significantly. The mid-$40’s WTI Crude Oil remains a pivotal zone from which stocks will move in unison. Should oil continue to fall to $42 or lower, our first support in the stock market basis the SP 500 Index is the 2030’s. If Oil retests its $39/barrel low from August then stocks would likely be retesting their lows as well. If Oil moves back over $48 then most US indices should be setting new record high prices in unison. 2160’s is our next upside target. The new consensus today that interest rates will rise has hurt Oil and stocks short term, but even lower oil prices and weaker economic data will be required to  push US stocks significantly lower. Until Oil prices falter beneath 42 and 39 a barrel we would expect buying opportunities on dips into year end. Investors remain 90% long the general stock market basis SP 500 and Nasdaq composite.

SP 11-2015

 

 

 

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