Since the beginning of June, the global stock markets have been in rally mode as investors bet EU leaders would save the day. The S&P 500 has been up 6% during this time. While some market pundits have expressed fears that the market is about to suffer a major decline, one indicator that has confirmed the recent stock market rally is the high yield bond market.
In a previous piece published on April 1, a day before the S&P 500 hit its 52-week high of 1,422.38, I discussed the warning signs the high yield bond market was sending equity investors. The warning turned out to be accurate as stocks turned lower for the rest of April and all of May. However, the high yield bond market is saying that the rally from the June lows is for real.
The high yield bond market, represented by SPDR Barclays Capital High Yield Bond ETF (JNK), has confirmed the recent rally. Now, as shown by the chart below, the high yield bond market and the stock market have performed about the same over the past year.
The large divergence I flagged in April has now come in substantially. It is important to note that, over the past year, investors would have done well to sell at times when stocks outperformed high yield bonds and buy stocks when high yield bonds outperformed stocks.
What Does It Mean?
The recent strength in the high yield bond market is a good sign for the stock market. However, the recent strength in the high yield bond market is not enough to be completely bullish. Rather, I would continue to watch the correlation as an indicator.
If the stock market continues to rally, but the high yield bond market does not, I would view this as a negative for equities. If both markets continue to move in lockstep, the indication is neither bullish nor bearish. In the event that the high yield bond market outperforms the stock market, I would view such a move as a bullish indicator for equities.