CAUTION: This stock market warning sign is flashing

From Jeff Clark, Editor, Market Minute:

There’s a cop car parked next to a stop sign at the bottom of a hill in my neighborhood.

Nobody is in the car. It’s just parked there – with its red and blue lights flashing – for several hours every day.

The idea is that, even though there’s no cop around and there’s no immediate threat of getting a ticket, the flashing lights will remind drivers to slow down and be a little more cautious. And it worked – at least for the first few days the cop car was parked by the stop sign.

Drivers got used to the cop car being there – without the cop. They got used to the flashing lights. So, they went back to driving carelessly and just rolling through the stop sign.

Yesterday, the city put a cop in the car. He tells me he wrote 12 tickets in his first two hours on duty.

The moral to this story is that even though there’s no immediate or evident threat of getting a ticket, drivers should still pay attention to flashing lights.

And so should investors.

In today’s stock market environment, the high-yield bond sector is the proverbial cop car parked next to the stop sign. The iShares iBoxx High Yield Corporate Bond Fund (HYG) has been flashing its warning lights for the past few weeks. Yet nothing has happened. There’s no cop in the car.

So, investors aren’t paying much attention to HYG anymore. HYG broke down in early November and hasn’t been able to recover. Junk bonds are badly underperforming the action in the broad stock market. And, in the past, such action has been a precarious sign for stock prices.

Two weeks ago, I advised traders to keep an eye on the chart of HYG. It provides a glimpse to the health of the “risk-on” environment. As long as buyers are stepping up to buy junk bonds, then investors have an appetite for risk and stocks are likely to keep pressing higher.

But if HYG starts to fall, then it’s an indication that “risk-on” may be shifting to “risk-off.” And stocks may start to struggle.

Well… here’s an updated look at HYG…

HYG has been acting poorly for the past several weeks. It’s trading below both its 9-day exponential moving average (EMA) and its 50-day moving average (MA). And the 9-day EMA is below the 50-day MA.

This is a bearish formation. For investors, it’s the flashing red and blue lights on top of the cop car. It’s telling you to slow down and be a little more cautious.

If HYG can somehow manage to rally and break above its 50-day MA, and if the 9-day EMA can cross back over the 50-day MA, then we’ll be back in “risk-on” mode.

Until and unless that happens, though, it’s best to proceed with caution.

You never know when the cop will show up.

Best regards and good trading,

Jeff Clark

P.S. You can sign up for my free daily market insights each morning in the Market Minute, right here. You’ll also receive a link to my “Guide to Option Trading” just for signing up. This free report will teach you how to trade options the right way… and dramatically boost your overall returns.

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