The smart money is betting on a selloff.
The high-yield market, or junk bond market, is in the midst of a major selloff, but while that may appear like bad news for stocks, if recent history is any indication, it could mean a very good buying opportunity.
Junk bonds are low-rated, fixed-income securities, but they tend to trade like stocks and as a result often act as a harbinger for the broader stock market. When they rise, equities tend to follow and vice versa
"They are a great proxy for equities because they are at the bottom of the capital structure," explained Gina Sanchez, founder of Chantico Global. "If you go down below that, you get to equities. So they are just a half-step above the lowest segment of the capital structure. They are a great tell as to what's going on."
With junk bonds now down so much, is the bottom about to fall out for stocks?
Katie Stockton, chief technical strategist at BTIG, believes that if recent history is any indication, the latest drop in junk bonds may be creating a short-term buying opportunity for stocks.
"Very close to the same thing happened ahead of the August low in the S&P 500," said Stockton, who noted that when the junk bond market did sell off in August, equities followed, but then quickly stocks rallied to make new record highs. "Indeed, the JNKs are positively correlated, but they are also chronic underperformers when you run them up against the S&P 500."
However, Stockton believes junk bonds should be compared with small- and mid-cap stock indices which have riskier sets of companies instead of the S&P 500. Suffering a similar fate to the JNK, the small cap Russell 2000 index is down 4 percent in the last 30 days.
Nonetheless, Stockton is optimistic about the S&P 500. "The move to the downside that we've seen recently appears very overdone," she said. "I am looking for a rebound similar again to what we saw in August, and that would likely be associated with a buying opportunity in the major indices like the S&P 500."
To see the full discussion on the JNK and the S&P 500, with Sanchez on the fundamentals and Stockton on the technical, watch the above video.