A leading indicator for stocks just entered a death cross, but the traditionally ominous signal might not be as scary as it’s cracked up to be.
The high-yield corporate bond ETF, the HYG, has fallen 2 percent from its 52-week high, with its short-term 50-day moving average crossing below its long-term 200-day moving average (the death cross) earlier this week. The last time this happened, the HYG plunged 20 percent from September 2014 to its low in February 2016.
High yield is typically viewed as a barometer for the equity market, as the two are highly correlated, but according to Craig Johnson, technical market strategist at Piper Jaffray, these warning signs may not be as reliable as people think.
“We’ve done some back testing on [the death cross], a lot of the damage is done before the cross actually takes place. I’d probably say 75 percent of the damage is already done from what we’ve found.” Johnson said Thursday on CNBC’s “Trading Nation.”
“You can also see on the chart that you’re getting a divergence right now between the S&P 500 and high yield. In the past that has signaled that perhaps there is a challenge ahead with the market,” he said. “We would disagree with that.”
The technician noted that the correlation between the S&P 500 and HYG fell to a three-year low earlier this fall, signaling to him to believe that investors have little to worry about from that aspect. Johnson has a 2,850 price target on the S&P 500 for 2018.
Larry McDonald, founder of the Bear Traps Report, expects further pressure on the high-yield market going into the next year.
“The biggest thing going on is we’ve had a big move in energy, so the default rate in high yield has improved because oil is up from mid-20s in 2016 to close to $65 now so that’s helping high yield,” he said on “Trading Nation.” “But if you look at the real driver in the last 12 months it’s been the European Central Bank. They were doing $2 trillion of economic stimulus of what’s called buybacks, asset purchases. And they’ve been buying some really poor-quality assets.”
“They’re buying so many high-yield bonds in Europe, that’s driving down yields here, this year. But if the ECB pulls back that’s a very, very big negative for U.S. high yield. We think that’s the biggest risk in the next six months,” he added.
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