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Guest Post: Time To Cut High Yield Exposure - Again

Tyler Durden's picture




 

From Peter Tchir of TF Market Advisors

Time to Cut High Yield Exposure - Again

Back on June 3rd I came out bearish high yield with a recommendation to short HYG or JNK or to buy SJB  That was based on several factors I was seeing in the market at the time:

1)  CDX indices were trading very cheap to intrinsic value
2)  slightly old new issues were struggling
3)  other markets, CMBX in particular, but European credit as well were extremely weak and were starting to leak into corporate credit market.

Since then I had become more neutral on the market as it had a significant decline (HYG went from 91.30 on June 1 to 87.88 last Thursday).  CMBX had stabilized, We were near the 200 day moving average on SPY and a lot of other risk assets and there was another obvious attempt to figure out a Greek solution. 

I am back to being bearish the high yield market.  I am not yet short it, but would certainly recommend being underweight right now.

A couple of things have pushed me back to being bearish.  The main one is weakness in other credit markets.  Once again CMBX is heading lower and back at or near its recent lows.  It has not been able to sustain a big rally which is particularly surprising because it is relatively illiquid and is a 'hedge' trade so is usually very exposed to a violent short squeeze.  Irish and Portuguese 10 year bond hit new record yields according to Bloomberg - 11.47% and 10.99% respectively at the time of the writing, though Portugal broke 11% earlier in the day.

I have argued that 'solving' Greece does not stop the potential contagion, just that it wouldn't be the first domino.  The realized losses on Greek bonds in the event of a default or restructuring with principal write-downs would hurt other banks and put pressure on the entire system.  That seems like it might be avoided for a while longer (though whether longer is a week or a year is anyone's guess).  What hasn't changed is the problems Ireland and Portugal and other over indebted countries face.  The contagion risk is still there, it just seems more likely that it will be triggered by another country, or else the EU will have to fight bailout fatigue and save another country, again, soon enough.

The 'fundamentals' of HYG and JNK are also scaring me enough to revert to being bearish.  HYG saw its shares outstanding remain stable for the first time since early June, but JNK saw another small reduction, even after relatively large ones on Thursday and Monday.  If the outflows continue, it will be hard for high yield to maintain current prices, particularly given how illiquid it currently is.  And how can you tell how illiquid it currently is?  Last Thursday's price move in HYG bears closer scrutiny.

The relative performance of the price of HYG and the NAV of HYG on Thursday and the subsequent price action is a clear warning sign that liquidity has broken down in high yield.  Last Thursday, HYG dropped almost 2%, and the NAV, which the ETF was already trading slightly cheap to, dropped only about 1/2%.  That is a sign of lack of the liquidity in the market.  Trading volumes dropped and bid/offers widened forcing even institutional investors to cut exposure via ETF's and CDS indices rather than selling bonds.  HYG has performed well since that Thursday - as have almost all other 'risk' assets.  What concerns me is that NAV continued to drift down Friday and Monday.  Clearly investors were waiting to sell some high yield bonds into strength.  I would be more optimistic for a strong bounce if the NAV had not leaked lower for 2 more days.  It did finally go up yesterday, but HY16 finished up almost a point yesterday, so a 1/4 point uptick in NAV on HYG is just not that bullish of a sign.

The combination of weakness in other credit markets, coupled by the HYG NAV confirming that liquidity is at an extreme low in the high yield bond market I think it is prudent to cut high yield risk.  With European credit closing quite weakly, I may shift to an outright short.

 

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Wed, 06/22/2011 - 12:04 | 1392032 I am a Man I am...
I am a Man I am Forty's picture

off topic, surprised no one has mentioned the fact brazil and india's yield curves are now inverted

Wed, 06/22/2011 - 12:10 | 1392043 qussl3
qussl3's picture

Werent you listening?

The BRICs are invincible, bulletproof, beyond reproach even.

Get with the program man.

Wed, 06/22/2011 - 12:08 | 1392052 LawsofPhysics
LawsofPhysics's picture

Ha ha.  Yep, and America will look just like them soon enough.

Wed, 06/22/2011 - 12:22 | 1392101 T-roll
T-roll's picture

I read an article on that topic somewhere last week. Global depression dead ahead!

Wed, 06/22/2011 - 12:09 | 1392039 Dan The Man
Dan The Man's picture

 

yah...but what does it all mean ?!?!?

Wed, 06/22/2011 - 12:21 | 1392081 chartcruzer
chartcruzer's picture

hard to say.   this article feels a bit premature.   hi yield has had a bit of a sell off, is on a PSAR sell, and has a nice rounded top building but there's no serious sell off in what is a long term up trend.

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3225058&cmd=show[s232907077]&disp=P

other bonds like international corporate are ok

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3225058&cmd=show[s232081816]&disp=P

investment grade corp are OK

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3225058&cmd=show[s233943224]&disp=P

US treasuries (10yr) are still solid.

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3225058&cmd=show[s234728341]&disp=P

lots of folks like to pick tops and this may be a top as QE2 winds down and interest rates start to rise.   Id rather wait for some kind of confirmation from the market itself.

of course,,,  in the end,,, in the long term,,   this interest rate manipulation by the FED and Planet Washington is rediculous, unsustainable, and an insult to we on mainstreet.   but that is another subject.

 

Wed, 06/22/2011 - 12:41 | 1392165 Highrev
Highrev's picture

As per the indicators on those charts there are some mighty bearish divergences building:

  • 9 month's worth of Class A divergences on the PHB.
  • 2 month's worth of Class B divergences on the PICB.
  • 1-2 year's worth Class A divergences on the LQD depending on the indicator.
  • 1 month short term of Class A divergences on the IEF with longer term (1 year) Class A divergences on the PPO.
Wed, 06/22/2011 - 12:54 | 1392216 chartcruzer
chartcruzer's picture

spot on.   let's see if the divergences play out....

Wed, 06/22/2011 - 12:07 | 1392048 LawsofPhysics
LawsofPhysics's picture

Not a bad plan, might be some reward (losing less?) for staying ahead of the oncoming onslaught of financial repression.

Wed, 06/22/2011 - 12:22 | 1392084 Fox Moulder
Fox Moulder's picture

Hmmm, there was a Yahoo Finance front page article this morning saying it was time to add junk bonds. (It's off the front page now and I am too lazy to look for it.)

Wed, 06/22/2011 - 12:27 | 1392106 TooBearish
TooBearish's picture

And go into what , 2yr notes at .35%?

Wed, 06/22/2011 - 16:55 | 1393134 oogs66
oogs66's picture

for what its worth, you would have saved over 1/2% or more than one month's worth of interest on hyg.

Wed, 06/22/2011 - 12:59 | 1392239 Mec-sick-o
Mec-sick-o's picture

I agree with illiquidity and deflation/inflation reduction until QE3.

More shocks into the productive sectors with price dislocation.

High interest rates and excessive debt (non-recognized losses) are still sucking up all liquidity.

Thu, 06/23/2011 - 05:37 | 1394057 Missiondweller
Missiondweller's picture

I cut high yield after 2009 after a 50% gain. I mean holy crap, take your gains and move on...into cash or gold.

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