ACTV - The Surreal Correlation Between Junk Bonds And Stocks
Summary
- The JNK ETF did not make another leg higher when the S&P attacked the 4100 level last week, which in my book is an indication that the stock market is a little ahead of itself.
- As we come up to the FOMC meeting tomorrow, the Fed needs to be reminded that the bigger part of the economic consequences of the fastest rate-hiking cycle in history will probably not be felt until summer.
- When we begin to feel the true impact of the last Fed rate hiking cycle, I suspect the junk bond market will weaken quite a bit, and that will have its repercussions on stocks.
A junk bond “reads like a bond but trades like a stock,” a veteran bond trader told me a long time ago, and a total return chart of the SPDR Barclays High Yield Bond ETF ( JNK ) and the S&P 500 Index surely demonstrates that. The JNK ETF did not make another leg higher when the S&P attacked the 4100 level last week, which in my book is an indication that the stock market is a little ahead of itself. As long as the S&P 500 holds the 2023 lows (near 3800), this rally can go further, but not without backing and filling.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Some economic indicators that are more sensitive to rising rates – like industrial production, retail sales, PMIs, and housing stats – have deteriorated notably since JNK and the S&P 500 made their lows in mid-October – while others, like weekly unemployment claims, dove under 200,000 last week, which is a sign of a strong labor market. This manic-depressive nature of the economy, where some indicators point to a recession and others point towards an accelerating economy, is a direct consequence of the COVID shutdown. Economies are not built to be shut down and we are witnessing the truly historic consequences.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
As we come up to the FOMC meeting tomorrow, the Fed needs to be reminded that the bigger part of the economic consequences of the fastest rate-hiking cycle in history will probably not be felt until summer. The Fed has done what it had never done before – push M2 Money Supply growth into negative territory (year-over-year), as I expected in this column (“ M2 Growth Goes To Zero ”), and I don’t think M2 is done falling, so I wonder what type of records we will see when all is said and done.
This horrific whiplash, where M2 grew (YOY) by 26.9% in February 2021 and then went to a negative 1.3% YOY growth in December 2022, is engineered by the Fed and the $6 trillion in COVID spending by Congress aimed at stopping a second Great Depression. They succeeded in that regard, even though we are paying for it with higher inflation and the rapid rate increases that followed. But because M2 growth cannot turn on a dime, I suspect the inflation readings will be quite a bit lower than what most observers expect by the end of 2023, as the M2 shrinkage is ongoing. Hence, the Fed should pause and reflect.
When we begin to feel the true impact of the last Fed rate hiking cycle, I suspect the junk bond market will weaken quite a bit, and that will have its repercussions on stocks. I also need to remind readers that February is the only month of the year that has negative expected returns for stocks over long periods of time. So far, January worked out exactly according to the seasonal schedule so February may do the same.
Also, it cannot be understated that the start of the new Russian offensive in Ukraine is expected by the end of February, which is arguably more dangerous than the original invasion and has a high probability of spilling outside Ukraine, given the huge support for the Ukrainian government from the West. The coming escalation is not discounted by the stock market in the West, given the troop movements on the ground.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Amid this misguided euphoria, the S&P 500 Volatility Index ((VIX)) made a new low for 2023 of 17.97 on Friday, highlighting investor complacency right when investors should be more worried. The last time I highlighted such a low in the VIX a couple of weeks ago we had a 130-point S&P two-day drawdown.
I think the same is coming again.
All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.
Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
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The Surreal Correlation Between Junk Bonds And Stocks