Month: June 2023

Stocks and Junk Bonds

Stocks and Junk Bonds: “This Divergence Appears Meaningful”
“Everything was aligned until February 2”

By Elliott Wave International

The trends of the junk bond and stock markets tend to be correlated.

The reason why is that junk bonds and stocks are closely affiliated in the pecking order of creditors in case of default. The rank of junk bonds is only slightly higher than equities because debt involves a contract.

Given these two markets are usually correlated, it’s worth paying attention when a divergence takes place. Indeed, a divergence is in the works now. In other words, while stocks have been holding up, the price of junk bonds have been trending lower for much of the year.

Here’s a headline from a few months ago (Reuters, March 16):

Investors shun high-yield bonds on recession, banking risks

At the same time, as mentioned, the S&P 500 and especially the NASDAQ has remained elevated.

The June 16 U.S. Short Term Update, which is a thrice weekly Elliott Wave International publication, discussed this divergence via this chart and commentary:

The graph shows that junk bonds diverged relative to stocks at the January 2022 peak, when stocks started their bear market. Both trends then came into alignment during the decline as well as the countertrend rallies that were interspersed in the selloff. Everything was aligned until February 2, which is when the yield on junk bonds made a low (shown as a high on the inverted chart). Yields then started to rise but instead of stocks declining, which would keep both trends side by side, equities continued to rally. This divergence appears meaningful.

The U.S. Short Term Update goes on to say that this divergence is not meant to be used for near-term market timing. But it is an indicator to keep in mind along with other indicators as well as the Elliott wave model.

If you’re unfamiliar with Elliott wave analysis or need to re-acquaint yourself, you are encouraged to delve into the definitive text on the subject, Elliott Wave Principle: Key to Market Behavior, by Frost & Prechter.

Here’s a quote from the book:

After you have acquired an Elliott “touch,” it will be forever with you, just as a child who learns to ride a bicycle never forgets. Thereafter, catching a turn becomes a fairly common experience and not really too difficult. Furthermore, by giving you a feeling of confidence as to where you are in the progress of the market, a knowledge of Elliott can prepare you psychologically for the fluctuating nature of price movement and free you from sharing the widely practiced analytical error of forever projecting today’s trends linearly into the future. Most important, the Wave Principle often indicates in advance the relative magnitude of the next period of market progress or regress. Living in harmony with those trends can make the difference between success and failure in financial affairs.

Here’s the good news: You can read the entire online version of the book for free once you become a Club EWI member.

Club EWI is the world’s largest Elliott wave educational community and is free to join. Moreover, members enjoy free access to a wealth of Elliott wave resources on investing and trading.

Get started by following this link: Elliott Wave Principle: Key to Market Behavior — get free and unlimited access now.

This article was syndicated by Elliott Wave International and was originally published under the headline Stocks and Junk Bonds: “This Divergence Appears Meaningful”. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

Treasury Bonds

Treasury Bonds: How This Forecast is Playing Out
Here’s what happened with a shelf of support in the chart of the long bond

By Elliott Wave International

The yield on U.S. Treasury bonds trended higher from 1942 to 1981 — that’s 39 years.

Interestingly, yields (or interest rates) then trended lower for 39 years (1981 to 2020).

Thirty-nine years is quite a long time — well long enough for observers to get used to the idea of exceptionally low yields, even the Fed.

Indeed, here’s a Sept. 16, 2020 headline from the Wall Street Journal:

Fed Signals Low Rates Likely to Last Several Years

Elliott Wave International President Robert Prechter had an entirely different perspective. Here’s what he said just a week later in his Sept. 23, 2020 issue of The Elliott Wave Theorist, a monthly publication that provides analysis of major financial and cultural trends:

On September 16, Fed Chairman Powell [said] he expected short-term interest rates to stay near zero as long as inflation stays below 2%, a condition he believes will maintain … through “the end of 2023.” I think there is not a chance in the world of that scenario playing out. … The probability is high that interest rates have begun a process of rising. … [emphasis added]

As we all know, interest rates or yields have risen substantially since 2020.

This chart and commentary from the May 19, 2023 Elliott Wave Theorist provide an update (Keep in mind that Elliott wave labeling is available to subscribers):

Treasury bond futures have been slipping again. As you can see in [the chart], bond prices broke a shelf of support this week and traded today at their lowest level in ten weeks. A debt crisis is brewing, and higher long-term interest rates will add to the pressure.

Yes, servicing public and private debt is getting a lot more expensive. And that debt has been increasing dramatically and rapidly (CNBC, May 18):

The global debt pile grew by $8.3 trillion in the first quarter to a near-record high of $305 trillion … .

Getting back to the price pattern of the U.S. Treasury Long Bond, Elliott wave analysis can help you determine what’s next.

Of course, no method of analyzing financial markets can offer a guarantee, but Elliott Wave International knows of no other method which surpasses the usefulness of the Elliott wave model.

That said, here’s a quote from Frost & Prechter’s Wall Street classic, Elliott Wave Principle: Key to Market Behavior:

Without Elliott, there appears to be an infinite number of possibilities for market action. What the Wave Principle provides is a means of first limiting the possibilities and then ordering the relative probabilities of possible future market paths. Elliott’s highly specific rules reduce the number of valid alternatives to a minimum. Among those, the best interpretation, sometimes called the “preferred count,” is the one that satisfies the largest number of guidelines. Other interpretations are ordered accordingly. As a result, competent analysts applying the rules and guidelines of the Wave Principle objectively should usually agree on both the list of possibilities and the order of probabilities for various possible outcomes at any particular time. That order can usually be stated with certainty. Do not assume, however, that certainty about the order of probabilities is the same as certainty about one specific outcome. Under only the rarest of circumstances do you ever know exactly what the market is going to do. You must understand and accept that even an approach that can identify high odds for a fairly specific event must be wrong some of the time.

If you’d like to read the entire online version of the book, you may do so for free once you become a member of Club EWI, the world’s largest Elliott wave educational community.

A Club EWI membership is also free.

Get started right away by following this link: Elliott Wave Principle: Key to Market Behavior — get free access.

This article was syndicated by Elliott Wave International and was originally published under the headline Treasury Bonds: How This Forecast is Playing Out. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.