High-Yield bonds funds saw record outflows of $7.1 billion this week - the fourth week running - as the slow-motion train crash in credit starts to accelerate.
As Forbes reports, the huge redemption blows out past the prior record outflow of $4.63 billion in June 2013. The full-year reading is now deeply in the red, at $5.9 billion, with 43% of the withdrawal tied to ETFs.
Simply put, everyone in the bond market knew 'not' to sell because liquidity is simply not there; but game theory's first mover advantage finally broke as retail investors run and create a vicious cycle of 'liquid' ETF selling forcing 'illiquid' underlying bond selling... just as we warned here and here.
Why should equity investors care? See chart below...
Bond managers are reaching desperately for protection in the CDS market - which is now at 6-month wides - but in the end are forced to liquidate holdings as ETF flows dominate...
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Between a sudden shift to a preference for "strong" balance sheet companies over "weak" balance sheet companies (the end of the dash for trash trade), and this rotation from high-yield to investment-grade, it is clear that investors are positioning defensively up-in-quality ending the constant reach-for-yield trade of the last 5 years.
Why should 'equity' investors care? The last few years' gains in stocks have been thanks massively to record amounts of buybacks (juicing EPS and also providing a non-economic bid to the market no matter what happens). This financial engineering - for even the worst of the worst credit - has been enabled by massive inflows into high-yield and leveraged loan funds, lowering funding costs and allowing CFOs to destroy/releverage their firms all in the goal of raising the share price.
Simply put - equity prices cannot rally for long without the support of high-yield credit markets - never have, never will - as they are both 'arbitrageable' bets on the same capital structure. There can be a divergence at the end of a cycle as managers get over their skis with leverage and the high yield credit market decides it has had enough risk-taking... but it only ends with equity and credit weakening together. That is the credit cycle... it cycles.
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Finally, as we concluded previously, there is little that the dealers can do if the selling continues as 'any' credit risk positions are unwound. The problem is that the Fed's dominance of the market and unintended consequences of controlling the repo/shadow-banking system have left bond markets more fragile than they have ever been.
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We await the Fed's decision on applying money market "gate" rules to high yield funds... it's for your own good!!