Junk Bonds Warn of Pullback in Stocks
The stock market continues to reach record heights, positive earnings have surprised consensus and the leading indicators on the economy look warm and sunny. Some caveats are the German resistance to European growth, the notable lag in small cap stocks in the US and High Yield Bond prices diverging with stocks.
Credit default swap and junk bond prices are typically in sync with stock prices. As High Yield Bonds fall in price their interest rates are rising which is a warning sign for stock indexes should they complacently move higher in contrast. This appears to be the 6th time stocks have moved to new highs while Bond prices diverged lower (yields higher). While this warning could be a couple weeks early and Bond prices could quickly reverse higher, this chart is warning of a stock market correction very soon. A short term peak may occur this week.
The range of corrections have been 3 to 10% from the intraday peaks in past occurrences. Given the excellent economic news and positive earnings picture combined with indicators showing that the retail sales, jobs and wages will continue to surprise the forecasters in the 1st half of 2015, we would favor only a modest correction at this time.
Investors can remain 90% invested in equities despite the correction that may occur in coming weeks.
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