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Seven Sigma Rally In LQD: Be Careful Where You Reach For Yield

Tyler Durden's picture




 

With 'safe-haven' yields at extreme lows (and negative in some cases), there is sense in 'reaching for yield' but - obviously - any increase in yield implies an increase in risk (and just because it is called a 'bond' doesn't mean its safer than an 'equity'). By way of example, moving to investment grade credit is the 'strategy du jour' of many asset allocators - "a little more yield and it's still IG after all." However, while this is a decent safety strategy overall - in a diversified and actively managed credit book, falling for the easy route of buying the liquid IG bond ETF LQD may run some into problems - no matter how much its 'price' tracks Treasuries. The last month has seen LQD experience a 7-sigma rally and it stands at multi-month rich levels to its intrinsic value (which implicitly places technical bids in the cash market). What worries us the most about LQD specifically is, we suspect retail investors who are piling in are unaware of the exposures within the portfolio of bonds. LQD is 24.3% weighted in financials - the very same Libor-rigging, beached-whale, NIM-compressing financials that are anything but 'risk-free'. As a reminder, an old adage from credit portfolio management, "the loss from losers far exceeds the gains from winners" and at these levels of price (and therefore yield) there is a lot of convexity in that risk-reward. Understanding the credit risk you are taking is key.

LQD trades very rich to intrinsics (lower pane) and has experienced an extreme rally in the last month or so...

and as is clear, shares outstanding have surged as investor interest in the 'safety' of the investment grade credit market has surged BUT with a 24.3% weighting in financials - just how safe is this ETF?

 

IG bond prices will track well with overall interest rates UNTILl there are events and those events will likely be centered around financials - whose credit risk is near its recent highs.

Critically, when you buy LQD or any IG bond ETF, you are buying the credit risk of the portfolio - that is what accounts for most of the difference in performance (and yield) from straightforward Treasuries - seems obvious but sometimes we wonder. The key point being - do investors understand the credit risk they are taking?

 

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Fri, 07/20/2012 - 09:39 | 2635715 zero19451945
zero19451945's picture

These kind of charts are everywhere.

Take a look at Walmart.

Fri, 07/20/2012 - 10:55 | 2636117 Carl Spackler
Carl Spackler's picture

 

"A rising money supply lifts all boats!"

                                         - Keynesian Accolytes 

< APPLAUSE>

 

"Thank you, thank you. I'll be here all the week.  Boy, I just flew in from Berlin, and are my arms tired !

(Ba-dump-BUMP!)

Did you hear the one about Hellen Keller?  Neither did she.

Fri, 07/20/2012 - 09:39 | 2635718 localpacific
localpacific's picture

Market Overview by FXCC this helps shed some light on the ZH article above 

Fri, 07/20/2012 - 09:40 | 2635720 LawsofPhysics
LawsofPhysics's picture

Crist, thanks for the head's up ZH.  I am out.

Fri, 07/20/2012 - 09:41 | 2635730 spastic_colon
spastic_colon's picture

still better than treasuries or stocks

Fri, 07/20/2012 - 09:41 | 2635734 Dr Benway
Dr Benway's picture

Only way to make money in this sick twisted market is to gamble big and hope for the best, or so people figure. Doesn't matter on what or which way.

Fri, 07/20/2012 - 09:48 | 2635773 Biggvs
Biggvs's picture

Any ETF's specializing in non-financial investment grade?

Fri, 07/20/2012 - 09:51 | 2635793 Flakmeister
Flakmeister's picture

JNK and HYG...

Caveat emptor

Fri, 07/20/2012 - 16:38 | 2637684 Biggvs
Biggvs's picture

Those are junk bonds though... I guess what I meant is investment grade ex-financials.

Fri, 07/20/2012 - 09:51 | 2635788 Flakmeister
Flakmeister's picture

I gave up on LQD when it flash crashed a while back...

Fri, 07/20/2012 - 09:51 | 2635792 DogSlime
DogSlime's picture

 

See - this testosterone-fuelled article is exactly the kind of risk-everything-and-party-like-there's-no-tomorrow attitude that is so eloquently criticised in the article of a few weeks ago: http://www.zerohedge.com/news/guest-post-real-testosterone-junkies

Why does ZeroHedge advise such recklessness?

Always the same - "throw caution to the wind and go balls-to-the-wall".

 

Fri, 07/20/2012 - 09:54 | 2635808 Yen Cross
Yen Cross's picture

Ohhh come on! Just buy some more Verizon.../sarc

Fri, 07/20/2012 - 09:54 | 2635809 The Count
The Count's picture

7-Sigma...etc...etc..etc...

This is all a bunch of concocted BS, pure and simple. Same as all those ingenious derivates that not even their inventors fully understand. 

Fri, 07/20/2012 - 09:59 | 2635825 RobotTrader
RobotTrader's picture

AGG, BND, TIP at fresh, new, world record highs again, despite $15 trillion in debt and counting.

 

Doug Noland must be staring at his screen with his mouth agape.

One paper bubble after another.

Fri, 07/20/2012 - 10:10 | 2635900 fonzannoon
fonzannoon's picture

One paper bubble after another?

Holy shit Robo, is that really you?

Fri, 07/20/2012 - 10:49 | 2636093 GMadScientist
GMadScientist's picture

It’s all created an extraordinarily mercurial backdrop.  The game of seeking to extract speculative trading profits from “crowded trades,” trend-following derivative trading strategies, and generally weak-handed participants has, itself, become one massive and dysfunctional crowded trade.  “Crowded Trade Squared,” a creature of prolonged policy interventions and incentive distortions, is a perilous predicament posing as a functioning marketplace.  Meanwhile, the backdrop seems to ensure the type of “Roro” volatility that wears down managers, performance and investor confidence.  This is the case for markets across the globe, in an era where market-based finance has never been as critical to global financial, economic and social stability.  And that amounts to an incredible accumulating cost the “inflationists” will continue to disregard.

Nope.

Fri, 07/20/2012 - 10:02 | 2635845 magpie
magpie's picture

Well, they don't really have any reason to prop everything up today, do they.

Fri, 07/20/2012 - 10:20 | 2635949 Quinvarius
Quinvarius's picture

It is the exit ramp, if you know what I mean.

Fri, 07/20/2012 - 10:24 | 2635975 Yen Cross
Yen Cross's picture

 I'm sitting on "Wall Streets" , exit ramp as we speak!

Fri, 07/20/2012 - 10:24 | 2635969 RobotTrader
RobotTrader's picture

Wanna see an insane bubble?  Check out HYD, the closed end leverage muni-bond ETF, hands down one of the biggest boners I've ever seen.

 

The leverage used in this thing must be huge.

Borrow 2-yr. Treasuries at world record low yields and reinvest in muni-bonds paying 5%.

Fri, 07/20/2012 - 10:34 | 2636019 Biosci
Biosci's picture

Some of those munis will be paying 15% soon.  Some 50%.  Will that make you recommend them even more?

Fri, 07/20/2012 - 10:52 | 2636104 GMadScientist
GMadScientist's picture

Depends....do I get a cheerleading squad as collateral?

Fri, 07/20/2012 - 12:34 | 2636158 Biosci
Biosci's picture

A whole squad? Now you're just being greedy.

 

Edit:  I didn't junk you

Fri, 07/20/2012 - 10:24 | 2635974 Double R
Double R's picture

the ratio between LQD and JNK has not changed that much since last August - they are both trending higher at the same rate... investors are not making a distinction. Also the TLT/IEF ratio is at the same level of Dec 2008... the panic search for yield is pushing investors to insane levels.

 

Fri, 07/20/2012 - 10:48 | 2636062 Matt
Matt's picture

Hey Tyler, looks like someone is copy-pasting your articles without giving credit:

http://singstock.com/world/seven-sigma-rally-in-lqd-be-careful-where-you-reach-for-yield/

EDIT: reason i mention is, google LQD and the singstock.com result is #5, while zerohedge doesn't show up until page 6.

Fri, 07/20/2012 - 12:52 | 2636650 i-dog
i-dog's picture

Google is slipping! Some months ago, ZH links were completely censored out. I posted on it here at the time.

Fri, 07/20/2012 - 10:51 | 2636100 bmusic
bmusic's picture

Other corporate bond sectors are similar, look at ENGN or AMPS

Fri, 07/20/2012 - 10:55 | 2636116 bmusic
bmusic's picture

I guess my question is, where else are you suppose to hang out?  Equities, Treasuries, Commondities, REITS, Cash? There is no where to run to and no where to hide.

Fri, 07/20/2012 - 11:49 | 2636357 Matt
Matt's picture

to repost FEDbuster from yesterday:

Ninety Miles An Hour Down a Dead End Street Posted by Ann Barnhardt - July 12, AD 2012 11:39 AM MST

 

People are emailing asking what firm I recommend.

NONE.

GET OUT. 
GET OUT. 
GET OUT. 
GET OUT. 
GET OUT. 
GET OUT. 
GET OUT. 
GET OUT. 
GET OUT.

The ENTIRE SYSTEM is totally, completely corrupt and therefore NO FIRM IS SAFE. Don't be stupid. Don't be obtuse. Snap yourself out of the Stockholm Syndrome that you are clearly stuck in. Get ALL MONEY out of the ENTIRE FINANCIAL SYSTEM, including stocks, bonds, retirement accounts, futures, EVERYTHING.

But what about . . .

What part of EVERYTHING are you not comprehending?

One. More. Time.

If you can't touch it, if it isn't physically on your property such that you can stand in front of it with an assault rifle and PHYSICALLY defend it, you don't own it, and it could be confiscated/stolen from you at any time, if it ever actually existed at all.

Fri, 07/20/2012 - 12:23 | 2636525 The Count
The Count's picture

My thoughts exactly. But for most its a total destruction of their belief system so they are like deer in the headlights.

Fri, 07/20/2012 - 13:34 | 2636864 covert
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