Stock-market investors are starting to freak out about this ugly chart – MarketWatch

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Wall Street bears are sounding alarms about a recent drop in non-investment-grade bonds, popularly referred to as junk bonds.

The SPDR Bloomberg Barclays High Yield Bond ETF JNK, +0.47% an exchange-traded fund that tracks junk bonds, finished at its lowest level since March 24. Another well known junk-bond ETF, the iShares iBoxx $ High Yield Corporate Bond ETF HYG, +0.22% also carved out late-March nadir, according to FactSet data.

Both ETFs fell below their 200-day moving averages early this month, signaling that momentum in fixed-income products is bearish. Technical analysts tend to follow short- and long-term averages in an asset to help determine bullish and bearish trends.

Read: Why stock-market investors should be worried about the junk-bond market

The moves for JNK and HYG, referencing their widely used tickers, come as the S&P 500 index SPX, -0.09% and the Dow Jones Industrial Average DJIA, -0.17%  have been testing fresh highs. Normally, junk bonds and stocks are positively correlated, or move in the same direction, because junk bonds are considered a proxy for risk appetite in the market. Junk bonds had been drawing interest, particularly in an environment of ultralow bonds, with the 10-year Treasury TMUBMUSD10Y, +2.74%  and the 30-year Treasury bond offering yields TMUBMUSD30Y, +2.43%  below their historic averages, even as the Federal Reserve embarks upon efforts to lift interest rates from crisis-era levels.

Bonds with the highest yields tend to be the riskiest and therefore offer a commensurate compensation in exchange for that perceived risk.

However, a recent divergence between junk bonds and stocks, taking hold in late October, has raised eyebrows among Wall Street investors (see chart above):

Courtesy Everett Collection

It’s getting ugly for junk.

As highlighted in MarketWatch’s Need to Know column by Victor Reklaitis, some market participants believe that a downturn in junk bonds can presage a broader unraveling of equities.

DoubleLine’s Jeff Gundlach is among that number.

The Wall Street Journal pointed out that the so-called yield premium, or spread, over going rates that investors demand to own junk bonds hit its highest point in two months on Wednesday, and continues to rise. MarketWatch columnist Mark Hulbert said the high-yield (or junk) spread, is currently in the vicinity of 3.5 percentage points, as judged by the BofA Merrill US High Yield Option-Adjusted Spread (see chart below):

“That means that junk-bond investors on average are requiring that they be paid a yield of just 3.5 percentage points more than if they had instead invested in Treasurys of the same maturities,” Hulbert writes.

Matthew Pasts, CEO of BTS Asset Management and co-portfolio manager of the BTS Tactical Fixed Income Fund, pointed out in a recent uptick in yields for Treasurys, also might be contributing to the downbeat moves in high-yield. 10—year Treasury yields were at 2.38% on Friday, up from 2.33% at the start of the week, and likely making the safety of government bonds more compelling. Bond prices and yields move in opposition.

“Over the past 12 months, we’ve seen several times when the Treasury market has appeared ready to challenge that 2.6% level, with Treasury bond prices cheapening further as the yield rises. During these times, the high yield market has wavered in its positive trend—not enough to shake our positive view, but definitely cautionary, Pasts said.

Check out: Tesla’s junk bonds are trading underwater and it could spell trouble for Elon Musk

Marty Fridson, CIO at Lehmann Livian Fridson Advisors, told MarketWatch that he doesn’t necessarily believe cracks in the junk-bond market spell doom for stocks, but they might result in a pullback.

“Can you have a little bit of a correction here just because things have gotten super tight? Yes,” he said.

On Thursday, stocks endured one of their more pronounced tumbles in months, with some pointing back to the high-grade market, including Gundlach:

That said, Fridson said economic fundamentals remain fairly solid, pointing to a recent third-quarter reading of U.S. economic growth showed the economy growing at an annual pace of 3%, according to the Commerce Department, after the second-quarter showed a 3.1% pace.

“People are looking for a reason to be a bit bearish, but more on valuations, but [high] valuations by themselves don’t cause the market to sell off,” Fridson said.