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The junk bond market is sending a bullish signal for stocks

Scott Gamm

High yield corporate bond prices are surging, which is sending a bullish signal for stocks.

That’s the assessment from Fundstrat Global Advisors managing partner and head of research Tom Lee.

Scrap yard pile of metal including tin bath

The iShares iBoxx High Yield Corporate Bond ETF, which tracks the Markit iBoxx USD Liquid High Yield Index, “looks ready to break new highs,” Lee wrote in a note to clients and as illustrated in a one-month chart below.

High yield debt prices

High yield corporate debt, also referred to as junk bonds, are seen as riskier assets because these bonds are usually from companies that are in poorer financial health and have higher probabilities of default. But they pay investors a higher yield as compensation for taking on this risk, which is usually referred to as credit risk.

“I am sure TINA [There Is No Alternative] is a big factor but high-yield has more credit risk and that is one reason it has had such high correlation to equities,” Lee told Yahoo Finance.

TINA is a phenomenon in which investors, hungry for yield, seek out riskier assets for fear of weak returns in so-called safer assets like government bonds.

“The high yield market leads stocks,” Lee said. “We have written about this in the past and it’s evident when looking at high yield around 2009 - it rallied even as stocks fell and that divergence marked the bottom.”

The S&P 500 (^GSPC) is up over 300% since its March 2009 low.

Inverted yield curve worries

Meanwhile, for investors worried about the inverted yield curve, where the 2-year Treasury yield trades above the 10-year Treasury yield (^TNX), Lee said historically, the inversion is caused by the Federal Reserve raising interest rates in an effort to slow down the economy. And the Fed just cut rates in July.

“The sole exception was 1998, where 'risk-off' caused a plunge in the 10-year yield. Sound familiar?,” Lee wrote. “Well, if you bought the S&P 500 on the date of that inversion, even after some tumult, one realized a 40% gain.”

RIsk-off refers to the notion of investors plowing money into bonds, which depresses yields. Bond prices and yields move in opposite directions.

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Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.

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