Why should we pay attention to what the junk bond market is telling us? Junk bonds are debt obligations from entities that carry a rating of 'BB' or lower by Standard & Poor's, or 'Ba' or below by Moody's. Junk bonds are so called because of their higher default risk in relation to investment-grade bonds.
In strong economic times, junk bonds are attractive to investors because they offer out-sized yields relative to investment grade bonds such as US Treasuries. The theory is that investors will buy junk when times are good because the corporations that issue these bonds have a strong economic environment in which to operate their business. This, in turn, increases the likelihood that the business can turn itself around and make good on its debt obligations. As investors buy junk bonds, also known as "high yield debt," the yield on those instruments will drop as price is inversely related to yield.
The opposite is true as well. In periods of economic contraction and weak consumer demand, these same businesses will tend to struggle, thereby increasing the chances that they will default on their debt. Investors are then much less willing to invest in junk bonds and, as a result, the price drops and the yields rise. Many analysts and investors watch the bond markets for turning points - for times when yield trends start to change. Remember, bond investors are considered the "smart money" and they typically are a month or two in front of the equity markets.
All that said, below are two charts from Kimble worth looking at. Not much to be optimistic about if you are an equity, that's for sure.