Listening to What Junk Bond ETFs Have to Say

Some market observers believe high-yield bonds and the related exchange traded funds have the ability to be an important indicator for the equities market.

With that in mind, investors should have a careful look at the charts of the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest high-yield bond ETFs. Long-term charts for HYG and JNK indicate the ETFs are inching below critical support, which could be a harbinger of equity market weakness to come.

“Many feel investors should ‘listen’ to the message coming from Junk Bonds, due to them sometimes being a leading indicator for the stock market. JNK and HYG could be breaking 5-year support, as they have been a little soft of late, while the S&P 500 has hit all-time highs,” says Chris Kimble of Kimble Charting Solutions.

Junk bond yields have been in decline for the better part of three years, but those yields recently started moving higher. Kimble notes that when junk yields rose in 2000 and 2007, weakness in the S&P 500 followed.

Problematic for HYG and JNK is lingering weakness in the oil patch because the energy sector’s percentage of the U.S. high-yield bond market has steadily climbed in recent years. Eager to tap North American shale plays from the Eagle Ford in South Texas to North Dakota’s Bakken Shale and a host of others, mid-level and smaller exploration and production companies have become some of the most prolific issuers of U.S. junk bonds in recent years. [Low Duration Junk Bond ETFs Have Less Energy Exposure]

However, many mid-tier and smaller E&P companies are poor generators of cash flow, stoking speculation that the U.S. high-yield market is close to seeing a raft energy sector defaults. JNK allocates 17% of its weight to energy issues while HYG devotes nearly 14% of its weight to bonds from oil and gas issuers.