Rajandran R Founder of Marketcalls and Co-Founder Algomojo. Full-Time Derivative Trader. Expert in Designing Trading Systems (Amibroker, Ninjatrader, Metatrader, Python, Pinescript). Trading the markets since 2006. Mentoring Traders on Trading System Designing, Market Profile, Orderflow and Trade Automation.

High Yield Bonds ETF and Stock Market Divergence Possible Warning Signs for the Overheated Markets

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It is interesting to see a long-running divergence between High Yield Bond ETF and the broader market since Feb 2021. These two asset classes generally move in tandem. If the stock market is up then High Yield Bond ETF will be up and if the stock market is down then High Yield Bond ETF will be down.

One can use the High Yield ETF JNK and HYG as a proxy for the Junk Bond Market. Typically it has a very high correlation with the broader markets.

What is a High Yield Bond?

A high yield bond – also known as a junk bond – is a debt security issued by companies or private equity concerns, where the debt has lower than investment-grade ratings. It is a major component – along with leveraged loans – of the leveraged finance market.

JNK Bond ETF

However, in the current situation, Broader markets are trading near the all high however that’s not the case with the High Yield Bond ETF(JNK/HYG) for the last couple of months (Since Feb 2021) and that is a possible warning for overheated stock markets.

HYG ETF

Why look for Divergence of High Yield ETF Vs Broader Markets?

High Yield Bond ETF divergence with Broader Markets is a better indicator of where the investors are parking their money in terms of corporate structure. Investors in high-yield bonds primarily are asset-management institutions seeking to earn higher rates of return than their investment-grade corporate, government and cash-market counterparts. Other investors in high-yield include hedge funds, individuals and arrangers of instruments that pool debt securities.

High-yield bonds have continued to be less attractive to investors over the last six months compared to investing in broader stock markets

US Broader Market – S&P500 Index

Generally, investors take high risk in investing in High Yield companies and High Yield Bonds and that involves a lot of risks as it involves higher interest payment. Typically those High Yielding companies are Non-investment grade companies and so the lenders get higher yields. Some times High Yield companies and High Yield Bonds are referred as junk bonds as it is risky.

In the present scenario, investors are risk-averse towards investing in high risk and high yielding bonds rather their focus shifted to the stock markets and that is an ominous sign and leading warning indicator about the economy.

Who should worry about it?

It is more of a medium-term inventory worry about the markets whose focus is to keep their investments for anywhere between 3-6 months of duration.

Rajandran R Founder of Marketcalls and Co-Founder Algomojo. Full-Time Derivative Trader. Expert in Designing Trading Systems (Amibroker, Ninjatrader, Metatrader, Python, Pinescript). Trading the markets since 2006. Mentoring Traders on Trading System Designing, Market Profile, Orderflow and Trade Automation.

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