It’s generally known that stocks are risky. It all hinges on how “hungry” investors are.
So, if investors’ appetite for risk starts to diminish, it stands to reason that this is not a positive development for stocks.
But is there a way to gauge investors’ risk tolerance so as to get an early warning sign before stocks start to tank?
Yes, keep your eye on the junk bond market.
You see, junk bonds also carry a great deal of risk because they’re issued by companies with the weakest balance sheets. Investors’ claim on assets in case of bankruptcy is usually next to the bottom rung, just one notch above equity holders. Hence, the trend in junk bonds often aligns with the trend in equities.
Here’s the important point: When the trends of stocks and junk bonds diverge, with stocks holding up as the value of junk debt declines, it’s usually a sign of impending trouble for stocks.
A past Elliott Wave Financial Forecast showed a historical example of such a divergence and said:
A countertrend rally high in prices for high-yield bonds occurred in February 2007, three months before the intraday extreme in the financials, five months before a top in the Dow Jones Composite Average and eight months before a top in the Dow Industrials. All stock indexes then crashed into the first quarter of 2009.
Now, here’s what you need to know in these closing weeks of 2021: Another divergence has been shaping up between high-yield (or “junk”) bonds and stocks.
Indeed, our Nov. 15 U.S. Short Term Update explains why…
…the tension created by the nearly two-month non-confirmation between HYG [a junk bond ETF] and the Dow is about to become more severe.
Both the U.S. Short Term Update and the Elliott Wave Financial Forecast are part of our flagship investor package.
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