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Last week we said investors should ignore the weekly jobless-claims report. It’s true that they were shocking, but they were already discounted in the market because the economy was effectively shut down.
This week we’re sticking to the same recommendation, even after the number of Americans who applied for unemployment benefits jumped by a record 6.6 million.
Instead investors should consider focusing on an early warning indicator. Let’s explore with the help of two charts.
Charts
Please click here for an annotated chart of the Dow Jones Industrial Average ETF DIA, -0.05%, which tracks the Dow Jones Industrial Average DJIA, -0.09%.
Please click here for an annotated chart of a high-yield bond ETF HYG, -0.01%. High-yield bonds are also called junk bonds. Another popular junk bond ETF trades under the symbol JNK, -0.02%.
Note the following:
• The first chart of the stock market is a monthly chart, giving investors a long-term perspective.
• The second chart of junk bonds is a daily chart, giving investors a short-term perspective.
• The first chart shows the “mother of all support zones” for the stock market.
• The mother of all support zones shown on the first chart should be the main focus. To learn more, please read “The stock market is getting dangerously close to the ‘mother of support zones.’ ”
• The second chart shows the drop in the prices of junk bonds as the coronavirus dislocation spread across the markets.
• The second chart shows countertrend rally in high-yield bonds.
• The second chart shows support and resistance levels for the high-yield bonds.
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Early warning indicator
The second chart is your early warning indicator for four reasons.
1. In a recession, junk bonds tend to perform more like stocks.
2. In my more than 30 years in the markets, I have consistently experienced that credit analysts tend to be more accurate than stock market analysts.
3. There is a high probability that junk bonds will break the support shown on the second chart before the stock market breaks the mother of support zones if the coronavirus situation worsens. I have previously written that the mother of support zones has an 80% probability of holding.
4. If junk bonds break above the resistance shown on the second chart, that will be an early indication that the coronavirus situation is getting better.
Semiconductor stocks have been leading indicators for the stock market. For this reason, it is important to watch semiconductor stocks such as AMD AMD, +0.73% and Micron Technology MU, +1.41%. It is also important to watch large-cap technology stocks such as Apple AAPL, -0.55% and Microsoft MSFT, -0.21%.
Protection bands
Even though the stock market has rallied from the lows, there has been no all-clear signal. As we have previously written, the sharpest rallies occur in bear markets. Rallies of about 20% are to be expected. In this coronavirus-influenced stock market, it is important that investors use an objective framework of protection bands before buying stocks. For details, please see “Stock market investors are asking ‘should I buy or sell?’ Here’s how to decide.”
Answers to your questions
Answers to some of your questions are in my previous writings. You can access them here.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.
