High Yield Signal Does Not Align With Long-Term Bearish Outcomes

High Yield Flips Cloud Script

The weekly Ichimoku Cloud chart below for the SPDR Bloomberg High Yield Bond ETF (JNK) shows a trend that rolled over in early 2022, formed a base in 2H 2022, and resumed an uptrend in 2023. Ichimoku Clouds look complex, but they are easy to understand. For the purposes of this discussion, the weekly trend is down when the “Bearish Odds Increase” conditions are in play and the weekly trend is up when the “Bullish Odds Increase” conditions are met (key bottom of image).

Bullish Turn July 2023

The look of the JNK chart below checks all the bullish boxes (green > price, price > red, blue > red, price > cloud, and cloud flips from red to green). The weekly close on July 21, 2023, was the first time all the bullish boxes could be checked since November 19, 2021, which speaks to increasing confidence about future economic and market outcomes. The fact that price, green, blue, and red are all above the cloud speaks to the strength of the trend and margin of safety.

Rare Bullish Flip

As shown in the chart below, a bullish move that sees price push back above a red cloud has only occurred two previous times in JNK’s history. We will examine the two previous cases to see what we can learn about risk and reward in 2023.

Sentiment Improves After GFC

Like many asset classes, high yield bonds were hit hard during the 2008 global financial crisis (GFC). Economic confidence began to improve in 2009, allowing JNK to check all the bullish boxes on September 18, 2009, which is similar to what occurred on July 21, 2023. The fact that price, green, blue, and red are all above the cloud speaks to the strength of the trend and margin of safety.

Since an improving weekly trend in high yield bonds speaks to decreasing concerns about a recession and bond defaults, we would expect risk assets to see improved performance after JNK completes a bearish to bullish flip. The SPDR S&P 500 ETF (SPY) gained 124% between September 18, 2009, and July 17, 2015. There were a significant number of normal and to be expected countertrend moves (give backs & corrections) between points A and B on the chart below, reminding us of the importance of maintaining realistic expectations about how markets operate in the real world.

2016: Economic Fear Subsides

Risk assets suffered significant drawdowns between mid-2015 and Q1 2016. Following the 2016 lows, increasing confidence in the credit markets was evident on August 12, 2016, when JNK was able to check all the bullish boxes, indicative of a much-improved weekly trend. The fact that price, green, blue, and red are all above the cloud speaks to the strength of the trend and margin of safety.

When the conviction of buyers is greater than the conviction of sellers in the high yield bond market, it speaks to confidence about future economic outcomes. 2016 was no exception with SPY gaining an additional 35% between August 12, 2016 and January 26, 2018.

QQQ and XLK After JNK’s Trend Flipped

In each of the three cases below, JNK dropped below a red cloud while checking all the bearish boxes and then pushed back above a red cloud and checked all the bullish boxes:

Case 1:  September 18, 2009

Case 2:  August 12, 2016

Case 3:  July 21, 2023

As shown in the table below, in the historical cases that featured significant drawdowns in risk assets followed by a significant recovery in JNK (cases 1 and 2), risk assets performed in a satisfying manner for those who endured normal volatility along the way.

High Yield Remains In An Uptrend

The more traditional JNK chart below with the 10, 20, and 40-week moving averages shows confidence in the high yield market remains on firmer footing relative to the vulnerable look in early 2022. If the September 2023 chart morphs into a look similar to early 2022, concerns about the sustainability of the rally would increase. That may happen very soon, but it hasn’t happened yet.

Know Your Timeframe

The timeframe of this analysis is important. It says little about whether the next 5% move in SPY is up or down. The analysis is helpful for investors with a long-term time horizon (years rather than days, weeks, or months).

Skepticism Is Part Of The Historical Script

While confidence had improved by the time the JNK signals were generated in 2009 and 2016, there was still a very healthy does of skepticism in both cases. In September 2009 market participants had the painful GFC fresh in their minds and not many would have guessed SPY would return 124% over the next 5-6 years. In the 2016 case, investors were dealing with uncertainty related to growth, interest rates, and the November elections, and yet SPY tacked on an additional 35% over the next 1.5 years. Thus, if you are skeptical today, that aligns with the 2009 and 2016 cases.

Moral Of The Story

In JNKs relatively short history, the signal generated on July 21, 2023, has only occurred two previous times, September 18, 2009 and August 12, 2016; in both cases the market’s final low was in place and investors who withstood normal market volatility were rewarded with satisfying returns. In the 2009 case, SPY gained an additional 124% over the next 2,228 calendar days. In the 2016 case, SPY gained an additional 35% over the next 532 calendar days. The returns for XLK and QQQ were constructive as well, simply telling us to keep an open mind about much better than expected outcomes in the next one to five years, which aligns with a recent QQQ signal, demographics, and long-term stock market trends.