If junk bonds slip, a big market drop will be ahead: Technician

The high-yield bond market and stocks tend to track each other closely. And for that reason, on technical analyst says a drop in the former could lead to a big slide for the latter.

"When the high-yield bond market has peaked, it's led to severe downturns we've seen in the S&P 500," Frank Cappelleri, a trader and technical analyst at Instinet, said Friday on CNBC's "Trading Nation."

Over the past five years, the correlation between the daily moves of the S&P 500 and the high-yield bond ETF (HYG) has been 0.73, indicating a particularly close relationship. This makes sense for economic reasons, given that both stocks and high-yield bonds should tend to rise as the economy gets better (making likely profits higher, and decreasing the risk of default).

"Right now, the HYG ETF is only about 2 percent below its recent high," which is "not alarming by any means, but we have to watch this relationship closely, based on the past."

"A downturn in the equity market could come as soon as we lose that bid in the high-yield bond market," Cappelleri warned.

For her part, Erin Gibbs of S&P Investment Advisory sees little reason for stocks to rally no matter what the high-yield bond market does.

"The equity market could be stuck in a trading range for some time until we see a catalyst to push the markets higher or lower," Gibbs wrote to CNBC on Friday.

Read MoreThe Trade: What junk bond rally means for stocks


Trades to Watch

Trader Bios


Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

Read more