How SJB Might Signal Market Turns

Jun.14.11 | About: ProShares Short (SJB)

By Bryan McCormick

For the last several weeks we have examined at the internals of the S&P 500 as a means of trying to get a better handle on why the index has been declining. In passing I have also shifted from analyzing specific stocks to looking at sectors, their weights within the index, and their impact on prices.

Today I wanted to look at an ancillary indicator that can be extremely useful for spotting potential turns, up or down, in equities in general. That indicator is the inverse of high yield bonds, in this case an ETF called the ProShares Short High Yield (NYSEARCA:SJB). It tracks, inversely, the performance of the Markit iBoxx Liquid High Yield Index, which is an industry benchmark for this type of bond.

The high-yield bonds tracked in that index are inherently riskier corporates, an asset class that has outperformed since market upturn began in 2009. As such, the underlying high yield index was a leading indicator for the turn in stocks. Bonds are more sensitive to changing economic conditions and therefore can be of great value in spotting trends and sentiment shifts.

The 20-day chart below shows the SJB in red and the S&P 500 in bar chart form. The area I want to highlight is the peak in the S&P 500 in the middle of the chart, where the red SJB line crosses to the upside above the zero-percent return line on the right axis. The turn in the SJB meant that traders are dumping riskier assets.

We can see that the SJB, after moving sideways, shot higher as the S&P 500 performed inversely. Shedding of risk became the predominant trading tactic at that point and accelerated as bonds deteriorated.

Turns in the SJB back toward the zero line could be a first indication of traders being willing to take on risk again. If that turns out to the case, it can be useful as a confirming indicator that shows the risk trade is back on. Continued outperformance in the SJB, however, is likely to suggest that there is yet more downside to come as risk-aversion remains dominant.

Keeping this indicator on your trading radar may give you an early advantage in changing fortunes for equities.

[Click to enlarge]

SJB vs. SPXClick to enlarge