Always consider hidden risks
US Not So High Yield Bonds : "It's Starting To Feel A Lot Like 2007"
( From Zero Hedge, Andrew Trasher, ETF Professor )
With Treasury yields at historic lows investors have gone after yield in other segments of the market, the high yield bond market is often one of the places investors seek out in that chase for income. Today we are going to take a look at the iShares High Yield Corporate Bond ETF (HYG).
Since December 3 last update on US High Yield Bonds, we had a breakout at 93 on the HYG ETFs. ( See Graph below )
Another one of the more prominent themes among bond ETFs last year was growing speculation that high-yield bonds were approaching bubble territory. Calls for asset bubbles is an old investing avocation, and since the global financial crisis, it seems that every time an asset class's popularity rises too quick for the comfort of some, a bubble must be right around the corner.
Talk of a junk bond bubble seemed to start in earnest in the second quarter of 2012, prompting a spate of coverage of the topic. Later in the year, there were reports of redemptions from popular junk bond ETFs such as the iShares iBoxx $ High Yield Corporate Bond Fund.
Those reports may have fueled the fire of the junk bond bubble prediction, but most mainstream media coverage of the issue ignored the fact that while HYG saw some modest outflows here and there, some other new high-yield bond ETFs became home to soaring inflows.
In other words, some important points about the efficacy of a junk bond bubble in the current environment are being missed, according to Market Vectors Portfolio Manager Fran Rodilosso.
"I think there is a difference so far between what we are seeing at the beginning of 2013 and the types of credit bubbles we have seen historically," said Rodilosso. "A bubble is built on excessive leverage, and modern bubbles have been fueled by leveraged buyouts, real estate speculation, and structured products with a high degree of embedded leverage."
While 2013 is still young, investors to this point, have scoffed at talk of junk bond bubble, sending major high-yield bond ETFs modestly higher to start the new year. HYG, the largest junk bond ETF by assets, is 0.7 percent to start the new year while its primary rival, the SPDR Barclays High Yield Bond ETF (NYSE: JNK) has gained 0.1 percent.
Noteworthy is the fact that the SPDR Barclays Short Term High Yield Bond ETF (NYSE: SJNK), JNK's short duration equivalent, now has almost $668.6 million in assets under management, according to State Street data. That is up from $518.7 million on December 4.
Clearly, quantitative easing, which has depressed yields on U.S. Treasuries, has contributed to a yield chase. However, as Rodilosso notes, credit spreads between junk bonds and Treasuries are not at concerning levels.
"Yields have been pushed down by a highly aggressive central bank policy, with the result that yield-oriented investors have been pushed into owning lower-rated credits," said Rodilosso. "As a result, the yields on riskier debt are as low as they have been. But the credit spreads, the difference between the yield on high yield bond and a Treasury security, are actually closer to their historic average."
One issue that may be fueling the junk bubble chatter is new issuance, which rose to an all-time high of $306 billion through the end of October.
In years past, that might have implied increased leveraged buyout activity or companies using debt to fund dividends, but Rodilosso highlights a different possibility.
"Whereas during a more ‘classic' bubble a vast majority of debut issuance has historically funded takeovers, dividends, and massive capital spending, 2012's record issuance was still, for the most part done for the purpose of refinancing. That refinancing was done at lower interest rates, reducing the cost of debt for many borrowers, while reducing the amount to be paid back over the next two years."
Rodilosso oversees $1.4 billion in assets across several Market Vectors ETFs, including the Market Vectors Fallen Angel High Yield Bond ETF (NYSE: ANGL) and the Market Vectors Emerging Markets Local Currency Bond ETF (NYSE: EMLC).
Not so Fun Damentals
Esther George, the president of the Kansas City Fed and this year a voting member on the Fed’s rate-setting committee, the FOMC, delivered a speech last week in Kansas City in which she specifically addressed the Fed’s role in skewing investor attitudes, and the possible consequences:
A long period of unusually low interest rates is changing investors’ behavior and is reshaping the products and the asset mix of financial institutions. Investors of all profiles are driven to reach for yield, which can create financial distortions if risk is masked or imperfectly measured, and can encourage risks to concentrate in unexpected corners of the economy and financial system. Companies and financial institutions, such as insurance companies and pension funds, and individual savers who traditionally invest in long-term safe assets, are facing challenges earning reasonable returns, and so they may reach for yield by taking on more risk and reallocating resources to earn higher returns. The push toward increased risk-taking is the intention of such policy, but the longer-term consequences are not well understood.
Of course, identifying financial imbalances, asset bubbles or looming crises is inherently difficult, as policymakers were painfully reminded during the financial crisis in 2008. Public transcripts of the FOMC’s discussions from as early as 2006 show participants were clearly focused on issues in the housing market and yet did not fully appreciate the risk to the economy from the financial sector’s exposure to risky mortgages.
Accordingly, I approach policy decisions with a healthy dose of humility when considering the long-run effects of monetary policy. We must not ignore the possibility that the low-interest rate policy may be creating incentives that lead to future financial imbalances. Prices of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels. A sharp correction in asset prices could be destabilizing and cause employment to swing away from its full-employment level and inflation to decline to uncomfortably low levels.
Simply stated, financial stability is an essential component in achieving our longer-run goals for employment and stable growth in the economy and warrants our most serious attention.
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But others are seeing the danger zone within the credit market.
The credit markets this week already look very different to how they ended last year. As BofAML's Barnaby Martin notes, beta-compression, flatter curves and credit outperformance versus equity have all been abundant themes of late. Relative value is still there, when one looks closely, but is unfortunately not what it used to be.
He adds that "things in credit have started to feel a lot like 2007 again," and while he believes the trend is set to continue (though slower) and the liquidity-flooded fundamentals in the high-yield bond market have been holding up well, it is trends in the leveraged loan market, that continue to deteriorate, that are perhaps the only canary in the coal-mine worth watching as global central bank liquidity merely slooshes to the highest spread product in developed markets (until that is exhausted).
The rolling 12m bond default rate among European high-yield issuers fell to 1.8% in December, whereas loan default rates rose to 8.5%. With leverage rising, the hope for ever more greater fools continues, even as everyone is forced into the risky assets.
Investment Grade bond spreads are now through post-Lehman tights
The monthly graph below show us a support at 93.50 ( low of June 2008 ). We have to respect price action but remember the momentum is fading in a declining volume environment...