I know a lot of folks are hoping for a Santa Claus rally to close out 2022…
Unfortunately, hope isn’t a great strategy when it comes to investing.
Although we’ve seen some rallying in the markets lately, we should keep a close eye on what the charts are telling us.
Take for example, the recent bullish action in high-yield bonds, which have enjoyed a sizeable rally.
The iShares High Yield Corporate Bond ETF (HYG) has gone up almost 7.5% since October 13.
This move in HYG has coincided with the rally in the broader stock market as well… the S&P 500 was up as much as 17.44% over the same period.
But now, it looks as though HYG is running into some technical resistance.
If HYG reverses course, then it’s likely stocks will fall as well.
Before I show you a price chart of HYG, I want to stress that the bearish pattern I’ve spotted isn’t complete yet.
But I wanted to get this price chart on your radar now, so you’ll know what to look out for if HYG starts breaking down hard.
It’s good to be aware of the worst-case scenarios – even if they don’t come to pass.
Now, let’s look at the HYG price chart below…
There are two important things going on with this chart…
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The blue lines highlight a chart pattern known as a “bearish flag.”
Bear flags are trend-continuation patterns. Once the pattern completes, it should draw the market to fresh lows.
For HYG, that would mean breaking below the October lows of $70.
A highly reliable signal that the pattern is complete would be a break below the lower boundary line of the flag.
Notice how prices have currently stalled along the upper boundary line of the pattern.
If HYG can’t break out above that upper boundary line by the end of the week, then it increases the odds the market will start trading lower.
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A bearish divergence (orange line) is forming in the Relative Strength Index (RSI) momentum indicator.
For HYG, bullish momentum peaked in late October when HYG topped out at $74.69.
Since then, HYG has kept pushing to new highs, but the RSI has started to trend downward.
This phenomenon is known as divergence. It occurs when the actual price of a market and the RSI are moving in opposite directions.
Bearish divergence is a strong, advanced warning of market weakness.
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The technical evidence in HYG tells me we should expect a bearish turn in the markets.
You see, the last time HYG broke down was from September 12 to October 13, falling over 7% in the process.
During that same period, the S&P 500 fell over 16%.
This correlation between the broader stock market and HYG is historically quite strong.
So, if HYG starts to break down again, it’s likely the stock market will follow.
That’s why it’s important to keep a close eye on this bear flag…
If HYG breaks below that lower boundary line, it’ll greatly dimmish the odds of an end-of-year rally in the markets… regardless of what everyone is hoping for.
Happy trading,
Imre Gams
Analyst, Market Minute
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