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Investment Grade Bonds And The Retail Love Affair
Via Peter Tchir of TF Market Advisors,
Without a doubt, retail has fallen in love with corporate bonds. Fund flows were originally into mutual funds, and have shifted more and more into the ETF’s. The ETF’s are gaining a greater institutional following as well – their daily trading volumes cannot be ignored, and for the high yield space, many hedgers believe it mimics their portfolio far better than the CDS indices.
The investment grade market looks extremely dangerous right now as the rationale for investing in corporate bonds – spreads are cheap – and the investment vehicles – yield based products.
LQD which is up to almost $20 billion in assets is a good proxy for the risk investors are taking. LQD has the advantage of being “market weight” the financials. After the stress tests, that is a positive since portfolio managers that were underweight financials will buy, and the “spread compression” opportunities could offset the rate risk. On the other hand, 4 of the top 10 individual bond holdings have maturities in 2037 and longer. There is an immense amount of duration risk. LQD is down about 2% from its recent higher. Not much, but with a yield of only 4.2%, that will take 6 months of carry to offset. Any investor who bought back in November at 110 is still in good shape, but virtually anyone who bought this year on the back of the Fed’s pledge of low rates is now underwater.
I do not like the move in treasuries. ZIRP can hold down the short end of the curve. Operation Twist can help keep the longer end anchored and focused on the short end, but that is more difficult to accomplish. The further out the curve, the less control the Fed has. With LQD having a very long duration and trading at a premium to NAV, I think there is room for more weakness here. Investors will learn that investment grade bond investments can lose money even as spreads tighten.
High Yield may also have far more rate risk than people realize. Typically HY can do well in a bad treasury environment, because the implied improvement in economic conditions helps spread more than the yield issue. But there is nothing normal about this “high yield” market. The market seems to have 3 distinct asset classes. Yield to call type bonds, that have low yields, but high spread, because they are trading to 2 or 3 year calls. There is virtually no upside left in these bonds. They will generally drift lower towards their call price – horrible convexity. Then there are “story” bonds. Bonds that require a lot of faith in management and the economic turnaround to be comfortable with. Any upside in the market is in these bonds. Finally, there are all the high quality “liquid” bonds that have decent duration. The problem is that most of these trade at relatively tight spreads, but also very low yields (certainly by HY standards). How many of these bonds can withstand a treasury sell-off without significant price action? High yield investors are particularly good at analyzing credit, they tend not to be as good at managing rate risk – since normally the move in rates is secondary.
With corporate bonds spreads (investment grade and high yield) already reflecting a lot of the move in equities, it will be critical to see how well they can withstand the pressure from the treasury markets – I don’t think they will do well near term, and would look near term declines in NAV and the premium to shrink.
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Funny thing about bonds....their yields are highest right before they go to zero.
Define investment grade again?
"you need to start with first priniples." In the world of Banking and debt markets that means "we start with the currencies first." Outcomes based analysis in finance is a fools errand. Don't even bother. In our modern financial system "it's all about data." WOW! And what data we have! But that means YOU START WITH THE CURRENCY FIRST..."how is the dollar doing" is what you need to ask before you go "full frontal" into the debt markets.
So Centrally Planned Market continues
Push folks out of fixed income into equities. Pump up mom and pop's retirement and etrade accounts. Make people feel richer in hopes of buying houses.
And re-elect The Hope and The Change
There is nothing free about this market
I used to bitch about this all the time but got sick of it. Sure, who wouldn't want a nice 5% yield on a quality corporate bond? But, like everything else, it's totally rigged to fool the muppets.
Go try to buy and bond and hold it to maturity, in your personal possession. Go ahead. I dare you. Where does 'retail' BUY A PHYSICAL BOND from a corporation?
Easy A: They don't.
Bonds are a good investment. Bond FUNDS are a horrible investment, a financial incinerator waiting for the On button to be pushed. Nothing but fees, churn, and market exposure on your principal.
You can't get a fucking bond to stuff under your mattress.
Idiots.
There are plenty still registered bonds that clients can hold, but why would you? Everything is held now in street regardless of form. Too much trouble and bullshit to get it out and back in when sold or matured.
Bearer and registered Munis are still available, registered corps are still produced.
So your mattress comment is worthless.
This is the time to sell if you've held all fixed income. I bailed on a lot of client positions last week.
Sitting in cash for a while.
Yeah, went searching in my broker's inventory a couple weeks ago for something low-quality IG / high-quality HY because I had a tad of free cash in one account. I simply could not believe the yields on any name + maturity / call I would be willing to shell out for. It is a smart move to sit and wait, especially with Treasuries finally weakening.
If the bond rally is over the metals rally is over too.
Hate to point out yet again how round the earth happens to be.