Subprime Crisis Affects the Stock Market
I’m sure you’ve heard of the subprime crisis and how that’s affecting the stock market. Well, keeping an eye on the iShares High Yield Corporate Bond Fund (HYG) can give you an advantage and insight into where the stock market’s headed.
It is well known to most investors that the stock market pales in comparison to the size of the debt market (also known as the bond market). Because of its shear size and potential for huge profits, the debt market attracts some of the most talented people to manage money. When people talk about smart money, the smartest money is usually managed by debt managers.
For example, when Enron was rumored to have accounting issues and the stock was spiraling downward, equity traders looked at the price of Enron’s bonds to determine if the rumors were true or not. When Enron’s bonds started to really decline, the equity traders sold. The price of a companies bond is very telling because they act like a canary in a coal mine. When the price improves it means good news is probably pending but if it declines it usually means something bad is coming down the pipe. Bond prices usually lead equity prices.
The subprime problem the market is trying to work through right now is causing bonds to go down in price, which is spooking the equity market. Because no one really knows how big a problem these subprime obligations may eventually be, smart money managers and hedge funds are looking to the corporate bond prices to give them a forewarning about a looming crisis. At this point in time, these prices have fallen but they have not collapsed to a point where stock investors feel they need to sell in size. The prices of corporate bonds have been going down steadily and slowly with no end in sight yet. They have not yet collapsed though.
Corporate high yield debt is the most sensitive to bad news because they have the highest risk of default. The HYG is an ETF holding a basket of high yielding corporate debt. Take a look at the HYG chart and you’ll see that these bonds have been selling off ever since Bear Sterns announced their hedge fund problems. Technically speaking, HYG has not formed a bottom yet, and the sell off in price has slowed. Whichever direction this ETF goes, the equities market will follow.
In summary, track the HYG if you want to be ahead of everyone else about the fate of this subprime issue. I just gave you a canary for the stock market.
Interesting post. I was wondering, though. How much weight do you put in volume and other numbers on ETFs. Afterall, outside of price, none of the other indicators are specifically reflecting the underlying security but instead more just the ETF (which I guess shouldn’t be too different…). Do you think this is problematic or is it safe to use non-price dependent indicators when looking analyzing ETFs?
[…] Subprime Crisis Affects the Stock Market I’m sure you’ve heard of the subprime crisis and its devastating effects on the market. Find out how you can profit by keeping an eye on the debt market. […]
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