Junk bonds are breaking down. And that’s a BIG caution sign for the stock market.

Last week, I warned readers to keep an eye on the action in the high-yield bond market. That sector looked vulnerable to a breakdown. And, since the action in junk bonds tends to lead the action in stocks, a breakdown in the high-yield sector would be a bad sign for the broad stock market.

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We got that breakdown on Tuesday. The iShares iBoxx High Yield Corporate Bond Fund (HYG) closed below its 50-day moving average (MA). The sector now looks ready to roll over. Here’s a look at the daily chart…

Similar breaches of the 50-day MA back in March and August led to steeper declines in HYG and coincided with pullbacks of nearly 2% in the S&P 500.

This time, however, the market might be headed for a larger decline.

You see, it’s not the action on the daily chart of HYG that concerns me the most. It’s the look of the weekly chart…

For the past year, HYG has been forming a bearish rising wedge pattern on the weekly chart. There’s significant negative divergence on key technical indicators like the MACD and RSI.

This sort of pattern usually breaks to the downside. And, since this is a weekly chart, any downtrend is likely to take several weeks to play out – as opposed to the quick selloffs we saw in HYG back in March and August.

As you can tell from the chart, HYG closed below the support line of the rising wedge pattern on Tuesday. It’s also below its 9-week exponential moving average (EMA). That’s bearish.

Of course, this is a weekly chart. So, if HYG can rally back above the support line and the 9-week EMA by Friday, then it can avoid a breakdown – for now.

But, if HYG finishes the week in this current condition, then the junk bond sector is likely headed for an intermediate-term correction.

And if junk bonds are selling off, then the stock market won’t be far behind.

Best regards and good trading,

Jeff Clark

Reader Mailbag

In today’s mailbag, we hear from a trading veteran with a key piece of advice…

I am 82 years old and have lived through all the economics of the past 50-plus years. The primary lesson I've learned? Beware of greed and fear!

Every financial writer has carefully researched his subject and can list numerous charts and figures to support his recommendation. It’s all sounding like the next “HOT” thing.

Beware of following when you feel greed or fear. They will almost always lead to loss. ‘Nuff said!

– James C.

If you have a piece of timeless trading wisdom you'd like to share, a question about option trading, or even a suggestion for the Market Minute or Delta Report, let us know right here.

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