Use high yield bond fund to time market and economy

As you might know, stock indexes are like chained pets walking with owners, sometimes they go too far, sometimes they stay too close, but they will stay in the course of their owner, which in investment cases are moving averages or trend lines.  So the day-to-day movement of stock indexes are mostly noise controlled by animal spirit, not driven by economic forces, so is there such a rational trading vehicle that moves slowly daily, has minimal day-to-day animal spirit driven noise, and sticks to ecnonmic force driven trend? The answer is yes, and they are high yield bond funds (HYBF).

Due to the fact the HYBF are more rational, they usually are good warning signals for stock market, as in good times, animal spirit tend to be overly optimistic, driving stock indexes to new highs as economic conditions starts to deteriot; while in bad times, animal spirit tend to be overly pessimistic, making stock indexes stay low for too long as economic conditions already starts to recover.

As HYBF day-to-day price actions are more rational than those of stock indexes, HYBF's moving averages are more reliable indicators in terms of avoiding day-to-day noises, and following underlying economic trends.  Such events as short term moving average, such as 50 day moving average, crossing over long term ones, such as 200 day moving average, usually indicate economic turning points.

Let's backtest our model, using JP Morgan High Yield Bond Fund (OGHBX), looking at 2007-2009 time frame.  In early June 2007, OGHBX topped at 6.31, 4 months earlier than stock market top in October, its 50D MA moved under 200D MA in Aug 2007, confirming economic deterioration; In mid Dec 2008, OGHBX bottomed at 4.39, 4 months earlier than stock market bottom in March 2009, its 50D MA moved over 200D MA in May 2009, confirming economic recovery was starting.

OGHBX chart from 2007-2009

Using this model, if we look at OGHBX chart now, although we are not certain whether 8.22 high in May 2011 was the near term top or not, 50D MA did move under 200D MA in August 2011, confirming economic weakness.

OGHBX chart from 2009-2011

Based on the above information, the following 4 scenarios are layed out:

• Scenario 1: OGHBX will make a lower high in next 4-6 months before heading down to lower low, at the same time stock index will make a higher high.  Probability: 40%.  Reason: this round of stock index correction is sharp, yet is still within 20% bull market correction range, therefore possibility of making a higher high remains.
• Scenario 2: OGHBX will make a lower high in next 4-6 months before heading down to lower low, at the same time stock index will make a lower high.  Probability: 30%
• Scenario 3: OGHBX will make a higher high in next 4-6 months (true top), stock market index will make a higher high.  Probability: 25%
• Scenario 4: OGHBX will make a higher high in next 4-6 months (true top), stock market index will make a lower high.  Probability: 5%