Bonds: High Yield
It is time to get out high yield. The sector has been seeing heightened fears for months, and prices have performed so well in the first two months of the year, that there is little value left. High yields returned 6.4% in January and February after the market came to a virtual standstill at the end of 2018. Part of the reason for the outperformance is that investors are demanding less spread to Treasuries, a fact that has not carried over to the investment grade market.
FINSUM: The pendulum has swung too far, and investment grade bonds now appear a much better value than high yield.
Today we wanted to write a story covering the topic of rate hedged ETFs. We have been examining these lately and feel they are in high demand because of the need for stable income for retirees and the still-relevant threat of higher rates. Mortgage REIT ETFs, such as iShares’ REM really caught our eye with 9%+ yields. However, they are very rate sensitive, so we wanted to find a better option. Enter ProShares’ HYHG, or the High Yield-Interest Rate Hedged ETF. The fund yields over 6% in a highly hedged manner, it goes long high yield US and Canadian debt and simultaneously shorts US Treasuries. The expense ratio is 0.50% and the fund has $127 under management.
FINSUM: This seems like a great fund to us—6% income with only 50 basis points in fees, all in a rate hedged package.
High yield had a very bleak run to finish 2018. The asset class went over 40 days without a single sale as the junk credit market seized up. However, it has made a comeback in a major way. The first five weeks of 2019 saw a staggering 5.25% gain in the Bloomberg Barclays US Corporate High Yield Index. New issues were quite oversubscribed (more than double), and the general mood has completely shifted.
FINSUM: The Fed backing off on rates sure makes a difference! It is interesting the market reacted this sharply given that high yield is relatively more insulated from rates. In our view, the turnaround is largely a relief rally that the Fed won’t push the economy into a recession.
The junk bond market may be coming back from the dead. The “December doughnut”, as it is being called, is now in the past, and the frozen market finally thawed this week with the first new junk bond sale since November. The market had gone 41 days without a sale until Tuesday, when $4 bn of new issuance went through.
FINSUM: A 41-day freeze and then 4 sales in one day totaling over $4bn. Demand was so high the companies were able to raise more than expected. Maybe the worst is behind the high yield market?
The junk bond market is going through an eye-opening drought. Not one company under investment grade has issued a bond since November, the longest spell of this kind in more than two decades. Investors are worried over the economy and market volatility, which has basically shut down any new issuance. It has now been 41 days since a junk bond sale, the longest period since 1995. December was the first month since 2008 without a junk bond sale.
FINSUM: When credit starts to get ugly, investors would be wise to pay attention. The question is whether this is just a short-term hiatus or a sign of worse things to come.
While the stock market is getting all of the attention, the bond market is experiencing a lot of turbulence as well. The riskiest corners of the debt market, including junk bonds and loans, are on pace for their worst month since the US downgrade in August 2011. High yield’s spread to Treasuries has surged a whopping 110 basis points since the start of the month, and unlike in stocks, there aren’t signs of a rebound. The average yield on the index is 8%.
FINSUM: It is reasonable to be nervous about credit right now given the huge volume of issuance in recent years and the pending threat of a recession and accompanying earnings slowdown.