Friday, August 28, 2009

Junk Bonds - I Mean "High Yield" Corporate Debt

are/is looking pretty "toppy." During a credit crisis/contraction, one would certainly expect to have high-risk corporate debt be a canary in the coal mine signaling a potential equity plunge (although, paradoxically, junky stocks like those that make up the U.S. financial system [despite their obvious insolvency] often rise at the end of a good bull run). The market's animal spirits are running in overdrive and bears are capitulating everywhere you look. It certainly is no fun to have a bearish outlook and/or bearish trade lately and watch the market steamroll the opposite way!

Fundamentals and short-term movements in markets are not correlated. Period. Let me repeat: fundamentals have nothing to do with daily or even weekly market price movements! I used to scour the headlines trying to figure out the news, but this is a mug's game and doesn't help traders AT ALL. One week, markets rally because oil is up, the U.S. Dollar is down or the latest doctored apparatchik report looks "better than expected" and the following week the markets tank for the exact same reason.

This is why Elliott Wave theory, technical analysis and market cycles are so interesting to many market participants. Trading the fundamentals leads to disaster over the short term and even the intermediate term. I have certainly learned a lot of expensive lessons during this bear market rally! If you think you can profit in the stock or other asset markets in the short term by trading the headline news or fundamentals, you will quickly find yourself broke and disillusioned. It doesn't work that way. The best opportunity for profit for novice investors is to figure out the long-term secular trend while it's still early, buy into it, ride it up to near the top, then switch into the next secular trend (easier said than done!).

I can tell you without hesitation that the longer-term secular trend in the Dow to Gold ratio is clear. Gold is rising in value relative to the Dow Jones Industrial Average/other major stock indices. This means that money is better spent buying physical Gold than buying general stocks until the Dow to Gold ratio gets to 2. Having said this, many don't care and want to make big money in the casino with short-term swings. Fear and greed, fear and greed...

Going long at these stock market levels makes no sense unless one is a day-trader with risk management skills, but trying to pick the exact top is very difficult and requires both skill and luck. I guessed the June highs would do it for this bear market stock rally (woops!).

Anyhoo, back to the topic at hand, which is corporate "junk" bonds, aka high risk/high yield corporate debt. When the yield is high, it means the risk is high. Remember that the next time you see a bank advertising an above-market yield on its savings deposits, money market accounts or CDs. Fortunately, the FDIC encourages moral hazard and excessive risk-taking by banks, which allows taxpayers to pay for the inevitable messes that occur via higher taxation, currency debasement, and new banking fees (thanks, big gov!). The FDIC "protects" citizens just like Homeland Security "secures" our borders and the federal reserve "fixes" financial crises.

Corporate junk bonds are looking "toppy" and demonstrate some bearish encouragement while recently failing to make new highs with the stock market. Following is a 2 year daily candlestick chart of the HYG ETF (i.e. "High Yield Growth" aka "You can trust us completely and we won't go bankrupt, but here's a higher yield just because we like you and we're running a special today"), a proxy for the junk bond market:

It will be interesting to see what happens over the next few weeks. Will junk bonds signal the next deflationary wave/next leg of the credit contraction before stocks top or will they top with equities? And what are the "toppy" looking Chinese and Indian stock markets (i.e. the drivers of never-ending global growth) trying to tell us?

Wikinvest Wire