High-yield bonds lagged stocks last week causing investors, us included, to question the discrepancy. Although performance of high-yield bonds and stocks can diverge, it is rare to see high-yield bonds decline in value while stocks increase and the 5% total return differential between stocks (as measured by the S&P 500 Index) and high-yield bonds (as measured by the Barclays High-Yield Bond Index) last week was particularly noteworthy. What does one market, high-yield bonds, see that the other, stocks, does not? The answer perhaps lies in the root cause of market weakness this summer: European debt problems. More specifically, we believe the bond market is paying greater attention to the financial health of European banks and whether troubles at European banks will spread to banks in the United States.

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