Junk Bond Risk Leading To Potential 'Blood In The Streets' Environment
Blog of HORAN Capital Advisors | Dec 14, 2015 06:06AM ET
Investor attention at the end of last week's trading was focused on the sharp sell-off in high yield bonds, better know as junk bonds. This sell-off was precipitated by the firm, Third Avenue, restricting redemptions on its Focused Credit Fund. Subsequent to Third Avenue's announcement, Stone Lion Capital Partners L.P. said here .
In reality, a better classification for the Third Avenue Focused Credit Fund is probably a distressed debt fund or special situation fund. The fund's "focused credit" reference means just that, the fund is highly concentrated with nearly 30% of the fund's assets invested in its top 10 bond holdings. In other words, the fund is not a diversified bond fund. Our clients know we eliminated our high yield bond exposure in July of 2014. One reason we sold the high yield exposure last year was due to the narrow spreads on high yield broadly as reflected by the red dot in the below chart. This tight spread characteristic is an indication of the rich valuation of the high yield asset class at that time.
The issues surrounding high yield are being felt in the equity market as high yield bonds and stocks are highly correlated . Last week the NASDAQ declined 4.1% with the S&P 500 Index and the Dow Jones Industrial Average both declining 3.8% and 3.3%, respectively. For the year, both the Dow and S&P 500 Index are essentially flat on a total return basis while the NASDAQ remains up a little over 4.0% year-to-date. On a price only basis, the S&P 500 Index is down 5.6% from its high in May.
The pullback last week has resulted in the CBOE Equity Put-Call Ratio spiking higher to .92 as can be seen in the chart below. As I have noted in earlier posts, P/C ratios over 1.0 are representative of an oversold market. The second chart shows the VIX index and this fear measure has also jumped higher to 24.4. Readers can track these fear measures here .
Get The News You Want
One near-term concern we discussed in a mid-November post was the fact that the On Balance Volume indicator (OBV) continued to show more trading volume on down days than on up days. This has been the case all year and has resulted in a downward sloping trend for the OBV a noted by the second white line in the below chart. From a positive perspective some technical indicators are beginning to look more favorable (CBOE P/C ratio noted earlier), but also indicators like the Full Stochastic Indicator below.
The risk developing in the junk bond market is a consequence of the Fed's extended near zero interest rate policy and investors feeling the need to reach for yield. Similar challenges have developed in the energy Master Limited Partnership (MLP) space. The belief is the Fed desires to begin removing the proverbial bunch bowl and raise interest rates at the conclusion of next week's Fed meeting. I suppose it is possible the recent issues facing the bond market could result in the rate increase being pushed into early next year.
Many of the headlines over the weekend were bearish ones with valid concerns about the high yield bond issues spreading into other areas of the market. On the other hand, this week's Barron's cover story highlighted 2016 forecast by ten strategists and all ten predicted higher equity returns for next year, with the average equaling 10%. With the issues facing the high yield bond market and a potential Fed rate hike around the corner, higher volatility in equities could face investors as the year nears its end. If this volatility is on the downside, Baron Rothschild, a member of the Rothschild banking family, is created with saying, "Buy when there’s blood in the streets, even if the blood is your own."
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.