The Daily Prophet: Stock Bulls Can't Ignore the Junk Bond Slump

Speculative-grade corporate bonds have been a very good leading indicator for markets in recent years. The evidence backing up that assertion is more than just anecdotal. A recent paper by Omri Even-Tov of the University of California at Berkeley concluded that high-yield bonds tend to predict the stock performance of a slew of issuers, especially on the heels of earnings reports.

So that’s why equity investors should be very concerned about this current slump in junk bonds, which has been more severe than the hit stocks have taken in response to rising concern over North Korea and its nuclear capabilities. The iShares iBoxx High Yield Corporate Bond ETF is down 1.38 percent from its recent highs in late July, while the SPDR Bloomberg Barclays High-Yield Bond ETF is down 1.28 percent. This may be more than normal market gyrations. Morgan Stanley warned a correction may be under way, adding its voice to a growing chorus of skepticism surrounding debt valuations, according to Bloomberg News’s Charles T. Clark and Rachel Evans. Junk-bond investors now receive an average of about 3.7 percentage points more yield than Treasuries, up 0.16 percentage point since Friday and heading toward the biggest weekly increase since April, according to Bloomberg Barclays index data. However, that’s still well below the average for the last five years of 4.7 percentage points.