The stock market has been on a tear in the past couple of weeks, seemingly putting all of its concerns behind it. As a matter of fact, this is one of the strongest rallies, in the shortest period of time, we have ever seen.
Many of my colleagues have talked about the forces driving it. And many of the stocks I’ve recommended in my Safe Money Report are participating. But is there any reason for concern? Any chinks in the armor, so to speak?
Well, I’d answer that by pointing to a market maxim: As go stocks, so go junk bonds. It’s a relationship that generally holds in all kinds of market environments.
You could say the same thing about convertible bonds and stocks. They generally track each other because a convertible is a hybrid security that offers some of the features of a traditional bond (coupon payments, repayment of principal at maturity, etc.) but also price upside tied to the performance of the underlying stock.
So with that in mind, take a look at the following three charts. The first shows the S&P 500 Index … the second shows the iShares iBoxx High Yield Corporate Bond Fund (HYG) … and the third shows the SPDR Barclays Capital Convertible Bond ETF (CWB):
What should jump out at you right away? Well, the S&P 500 just hit a record high of around 2,040 this week. But the HYG is nowhere near its high from June, and has actually made two lower highs and lower lows since then.
The CWB did manage to make a slightly higher high in late August than in June … but it too hasn’t gotten anywhere near its yearly highs yet.
So what’s going on?
Could it be that energy debt is underperforming because of the pullback in crude oil, therefore weighing on the higher-risk lending market overall?
Is the rotation of money out of ALL bond funds and ETFs — and into stocks — causing outflow-related selling in bonds, regardless of type?
Or is it something more serious? The credit markets have a history of sniffing out economic problems and future market threats earlier than the stock market. So it’s possible the divergence between stocks and credit-sensitive debt is pointing to something lurking behind the scenes.
It’s too early to tell which answer is the right one, frankly. But I would keep an eye on these divergences to see if they persist or worsen. At the same time, I still think you can profit from the rally in stocks by using equities that get the best Weiss Ratings, that have company-specific positives, and that are in strong underlying sectors.
Until next time,