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Junk bond ETFs are sending an important market signal

At the beginning of the year, the stock market was led by a rise in safer, defensive positions.

But now, it's all flipped around: new highs have come as investors have moved into higher-risk trades.

Junk bonds are one example of a high-risk trade that is on fire. July is on pace for $4 billion of high yield ETF inflows, which would make it the biggest month in almost five years.

Just in the last two weeks, exchange-traded funds tracking U.S. high-yield bonds have seen a net inflow of over $2 billion — four times the inflow of the previous month, according to data from Markit. At this pace, monthly flows could exceed $4 billion, which would make July the biggest month for high-yield inflows since January 2012.

Those inflows have boosted popular ETFs like the SPDR Barclays High Yield, which is up 3.6 percent in a month. The iShares High Yield Corporate Bond fund is also up 3.3 percent in the same period.

Low interest rates have investors scrambling for higher-risk assets, and upswings in the stock market instill greater confidence in the market as a whole.

When stocks move up or down, the high-yield bond market tends to move in lockstep. That relationship has been even stronger than normal in recent months.

The 50-day rolling correlation between the SPDR Barclays High Yield ETF and the S&P 500 is nearing 90 percent, the highest level reached in the eight years that junk ETFs have been available. The last time that the correlation between stocks and high-yield ETFs was this high was in early 2012.

Investors often track high-yield bonds in an effort to gauge risk appetite and predict any potential turns in market sentiment.

So far this year, the S&P 500 has been driven by sectors that are traditionally considered safe investments like utilities, materials, telecom and consumer staples as investors seek out safety during periods of volatility. But as markets reach new highs, that sentiment seems to be changing.

Flow data from Markit shows that investors are more willing to make bets on sectors that have been lagging this year.

Financials, for example, has been underperforming the broader market this year, but have led inflows so far this month at $450 million. The consumer goods and consumer services sectors followed financials with more than $200 million each in inflows during the same period. The materials sector ETFs continue to attract investment with $448 million in inflows this month.

On the flip side, sectors that performed well during the first half of the year are now seeing money coming out of them.

Utilities and energy had done extremely well from the beginning of the year until the end of the second quarter, but as the second half begins, both sectors are seeing significant outflows. Month-to-date, the two sector ETFs have seen almost $400 million and $300 million in net outflows, respectively.

Some believe that the appetite for risk has increased as concern about Brexit has evaporated in recent weeks. High-beta stocks have outperformed the market average so far this month, and short interest has declined for those stocks, signaling a "true" rally, said research analyst Simon Colvin at Markit.

"The general mood in the market this month is risk-on, shown by investors rotating into riskier parts of the market," Colvin said. "Low-beta stocks may still continue to attract investors. The momentum right now, however, belongs to stocks beaten down this year."