foxex: Investors Haven’t Abandoned Junk Bonds

Chart Advisor | Focus on the Price

By John Jagerson, CFA, CMT

Friday, February 08, 2019

1. Earnings catalysts can change trends

2. S&P 500 retests former resistance

3. Junk bonds confirm confidence

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Major Moves

If you wanted to find an example of an industry that had been under-performing for years, the Toys & Games industry would have been a good place to look.

One of the industry's components, Mattel (MAT), hit its highest price point during the last bull market all the way back in 2013 and has been falling ever since. The drop has been so severe, MAT actually fell to a lower price point in late-December 2018 than it did following the 2008 Financial Crisis.

However, MAT got a temporary reprieve today in the aftermath of the company's earnings announcement after the closing bell on Thursday. MAT beat revenue estimates by $80 million and earnings estimates by $0.23 per share – coming in at $1.52 billion and $0.04 per share, respectively.

Traders reacted to the earnings beat and strong growth in Barbie and Hot Wheels sales during the holiday shopping season by sending the stock soaring up through long-term down-trending resistance in after-hours trading. This move marks a confirmed breakout of the stock from the down-trending channel it has been in.

Of course, there are no guarantees MAT will continue to rally, but this breakout is the first step in what could be a new bullish uptrend.

This is something we have been seeing a lot of this earnings season: stocks that were either consolidating, or drifting lower, breaking above resistance.

It's no surprise that we're seeing this. Earnings announcements are often the catalysts for long-term trend changes. Traders are forced to instantaneously adjust to new information, and that new information can change analyst outlooks.

In this case, one analyst at BMO Capital has raised his 12-month price target for MAT to $23 – a price the stock hasn't seen since June 1, 2017.

The fact that MAT pulled back from its intra-day high just above $16 does signal traders may not be willing to jump on board the long-term uptrend bandwagon just yet, but seeing the former down-trending resistance level holding up as support during this re-test by the stock is encouraging.

If MAT can remain above $14.50, it has an excellent opportunity to continue climbing.

S&P 500

The S&P 500 has pulled back from its down-trending resistance level during the past few trading days, but it is showing signs of resilience in the face of profit taking heading into the weekend.

The index has managed to remain above 2,675.47 – the level that serve as resistance while the S&P 500 was consolidating in late-January but is now serving as support.

Traders who are looking for confirmation that this bullish uptrend still has legs will be thrilled to see that the two sectors that provided the lion's share of the lift on Wall Street today were Consumer Goods – driven by Mattel (MAT), which soared 23.22% higher, and Mohawk Industries (MHK), which rose 5.91% – and Technology – driven by Motorola Solutions (MSI), which jumped 14.12% and Electronic Arts (EA), which climbed 16.05%.

Typically, strength in these two sectors is a sign of expected economic growth in the future and trader confidence on Wall Street.

Read more:

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Retracement or Reversal: Know the Difference

ETFs For Sector Rotation Strategies

Risk Indicators - Relative Strength

One of the best places to look outside of the stock market to confirm whether traders are confident or apprehensive about the future is the junk bond market.

Junk bonds are corporate bonds with a credit rating from Standard & Poor's (S&P) of BB, or below, or a credit rating from Moody's of Ba, or below. The lower a company's credit rating, the more likely it is to default on its debt.

When traders are confident in the future, they are more willing to put their money at risk by chasing after the higher yields junk bonds offer. This pursuit of higher returns typically pushes the price of junk bonds higher as traders rotate money out of safer trades and into more aggressive positions.

Conversely, when traders are less confident about the future, they are less willing to put their money at risk. This avoidance of high-risk trades typically pushes the price of junk bonds lower as traders sell their positions and move their money to more conservative investments.

Looking at the chart of the SPDR Bloomberg Barclays High-Yield Bond ETF (JNK), you can see that traders have been moving money back into junk bonds since December 26, 2018.

While the most dramatic rise came during the first week of trading in 2019, junk bonds have continued to climb higher during the past month.

This week's up-trending consolidation range signals traders are still looking for more growth and an accommodative financial environment during the rest of Q1 2019. If traders were nervous about another bearish turnaround in the U.S. stock market, they would be bracing for the decline by offloading more of their junk bond positions.

Why the Debt/EBITDA Ratio is Crucial to Junk Bonds

High-Yield Bonds: The Pros and Cons

Bottom line: Trader confidence intact

While there are certainly concerns on Wall Street that earnings growth is going to slow – potentially dropping into negative year-over-year growth territory – during Q1 2019, those concerns don't seem to have derailed trader enthusiasm. As long as companies continue to beat earnings expectations for Q4 2018 and traders continue to move into higher-risk assets, the S&P 500 is likely to remain stable.

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