High-yield bonds warn that the S&P 500 could fall
- High-yield bonds are giving warning signals that suggest the stock market will retest its January low, according to Bank of America.
- The bank pointed to bearish breakouts in the high-yield bond index over the past few weeks.
- The leading indicator is a sign that credit markets are bracing for volatility that could spill over to the stock market.
A key leading indicator of bearish stock market action is the flashing of warning signals, according to a Wednesday note from Bank of America.
The high-yield bond index is starting to tumble, which has always been a reliable predictor of a stock market pullback, according to the bank. The bearish technical action in high yield bonds suggests that the S&P 500 could test and break below its January low of around 4200 later this year.
“This week we are showing bearish breakouts for the iBoxx USD Liquid Investment Grade Index and the iBoxx USD Liquid High Yield Index which are a potential bearish leading indicator for a break below the 4200 area support on the S&P 500,” said explained the bank.
This represents a downside potential of at least 8% from current levels and would indicate that rising inflation, soaring commodity prices and anticipation of higher interest rates could dampen the economy. .
In addition to the bearish high-yield bond spread, the option-adjusted spreads of the high-yield bond index have formed a base and are pushing higher, which is another worrying sign of risk aversion. which credit markets are gearing up for.
which could ultimately spill over to the stock market.
If the S&P 500 is unable to hold support around 4200, further decline is likely in the 3800-4000 range, according to the bank, representing a potential decline of up to 17% from current levels. This would align with BofA’s observation that midterm election years see an average correction of 20%.
The decline in FINRA margin debt from record highs of the past two months is not helping equities, which could dampen demand for stocks.
“With signs of credit cycle maturity and deleveraging, as well as expectations that the FOMC will raise interest rates, investors may prefer to hold cash rather than relatively more expensive cash. [margin] debt… We see this as a market risk for 2022,” BofA explained.