Some Non-Hyperbolic Junk Talk

Authored by Kevin Muir via The Macro Tourist blog,

If you are looking for some breathless post about the recent collapse of the junk and high-yield market over the past couple of weeks, then click somewhere else.

I know it makes for exciting writing, but I won’t do it. There is already more than enough hyperbolic rhetoric filling the financial airwaves.

But the really amusing part? Have any of these doomdayers actually had a look at the return of these bond markets over the past year?

I hate to use ETFs to generalize an asset class’ returns, but the HYG and JNK ETFs seem to be on everyone’s lips as the epicenter of the recent terrible high yield “rout.” Heck, even newly crowned Bond King Jeffrey Gundlach watches JNK technicals for clues.

Let’s have a look at these awful “technicals” for HYG and JNK.

Yup. I can see why pundits are talking about the decline. It sure looks scary.

But is it? Both ETFs are bond funds - which means they pay interest as dividends. When examining the return of these assets, it is important to include these “interest payments” in the calculation.

What does it look like if we put these payments back into the equation?

Both the HYG and JNK are up approximately 5% year-to-date on a total return basis. So remind me again about the “rout?”

Spreads are even better behaved

Most bond traders talk about high yield and junk bond pricing as a spread against US treasuries. If a 5-year corporate bond is priced to yield 4.07% with the US t-note equivalent maturity trading at 2.07%, then the corporate is described as trading with a spread of 200 basis points.

This spread to treasuries represents the extra risk buying a private corporation versus the risk-free sovereign. If there was truly a high-yield rout, you would expect this spread to blow out.

Maybe I am wrong in my analysis of this high-yield “rout” being nothing to get excited about. Maybe spreads are blowing out, signaling increasing worry about private credit.

Well, let’s explore that possibility. Here is the one-year chart of the BarCap US High Yield 10 year spread. An increasing rate represents a widening of the credit spread, meaning corporate bonds are increasing in yield faster than US governments.

In this light, it sure seems like the last month is pretty minor.

What about if we back out the time frame. Maybe we need to look at the bigger picture.

Whoa! This recent uptick in spreads is barely a blip.

What about a really long-term view?

Holy smokes. The last month’s widening doesn’t even register.

The start of something bigger?

Just because the recent high-yield and junk bond decline is minor compared to previous declines, doesn’t mean it’s not the start of a bigger correction. That very well could be. I am not predicting future price action, but merely reminding everyone to take a deep breath, and think about the scale when they are discussing the “rout” of the past week.

But I will reiterate my belief that the next crisis will not emanate from the private credit markets, but will instead occur when the entire bond market revolts against the insane monetary policies of the world’s Central Banks. Sure, JNK and HYG will decline. I have no doubt about that. But more importantly, TLT and all the other supposedly risk-free sovereign bonds will lead the way.

And although I am extremely worried about the precarious overbought nature of the stock market, the fact that JNK and HYG are declining is no reason to get out extra pink tickets.

The recent slight widening of credit will not cause the stock market to decline. Do you really think it makes any difference to corporate balance sheets if credit spreads back up 50 basis points from the lows? Not a chance. When it starts moving 500 basis points I will be more sympathetic to that argument. But the recent backup is just noise, and irrelevant.

Coincidental as opposed to causal

But I will concede one point. In this day and age of Central Bank quantitative easing pushing up all financial asset prices together, the fact that bonds are declining might not be enough to cause a stock market dip, yet it might be a signal that the bid for all financial assets is wearing thin.

HYG and JNK’s recent poor performance might be reflective of the drying up of all bids for all financial assets.

Don’t misconstrue this as some sort of end-of-the-world call. Nothing could be further from the truth. I am desperately trying to keep everyone’s perspective firmly in check with this supposed high-yield “rout.”

Just remember, the backup in JNK and HYG is coincidental, not causal to the coming risk asset correction.

Comments

BANKERS-WE ARE… Tue, 11/14/2017 - 08:37 Permalink

keep printing....nothing to see here.The only thing to end it all will be BITCOIN. When BTC hits 100,000 a coin in 2018, it will pull enough from the dollar that a global dollar apacalyptic dump wil begin. In five years if you try to pay for something in dollars. They will laugh at you. The greatest weath transfer from the baby boomers to the now generation. And they have no clue its happening.

quesnay BANKERS-WE ARE… Tue, 11/14/2017 - 10:53 Permalink

Bitcoin at 100000 represent about 2 trillion (from all over the world, not just US). I don't think that's enough to do it.US GDP - 20 trillionWorld GDP - 80 trillion.World total net worth - 250 trillionAlso, how will the entire world use bitcoin when it can only manage less than 4 transactions per second?https://www.smartbit.com.au/charts/transactions-per-secondFor 80 trillion GDP the average transaction would have to be worth $640,000 ;-)

In reply to by BANKERS-WE ARE…

taketheredpill Tue, 11/14/2017 - 08:55 Permalink

Need to understand the Liquidity issue.  Central Banks hace been quietly pushing ETFs to establish backup liquidity provisions.  The problem is the liquidity mis-match between the ETFs (large and liquid) and the under-lying (sell by appointment). The writer is correct in that the current weakness may not be the beginning of the end. BUT if this really is the end the HY ETFs will turn into death-traps that will erase years of excess returns very quickly.So you have to either be in or out.  The mistake is thinking you can be "nimble".Also, buying HY when spreads are at 3.2% is like watching a stock fall from $5 to $0.50 and then deciding it's the perfect time to short.Last point, the "Interest" he talks about is a big fat juicy extra 320 bp.  Compared to average spreads of 800 bp or more? PAss.