Junk Bond Selloff: More Than A Pullback?

August 12, 2014

Two readily accessible data series suggest something else is brewing in the high-yield market.

My colleague Cinthia Murphy recently pointed out—in the piece “Investors Losing Love For Junk Bond ETFs”—that U.S. corporate high-yield ETFs have been under heavy pressure recently. Some of the most prominent high yield ETFs experienced massive redemption and losses in July:

These asset losses came as the performance of these funds also took a nose dive, as the chart below shows. For comparison’s sake, I’m plotting HYG, JNK and HYS against the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD | A-75) to show the year-to-date performance of the U.S. corporate investment-grade segment versus high yield.

Total_Return

What the chart tells us that the sell-off seems to be isolated in the high-yield space rather than a broader corporate credit phenomenon. Indeed, LQD’s performance fared relatively well despite a $472 million net outflow in July.

It seems investors were rotating out of the risky part of the fixed-income market because they either thought they were not being compensated adequately for the risk—and there are better options elsewhere—or they believed corporate credit quality is deteriorating and default rates are going to spike.

The question we are faced with is, Was the sell-off just a pullback, and an opportunity to get in the junk bond space, or a reversal of broader market sentiment?

Looking at the options-adjusted spreads (OAS) and credit default swap (CDS) spreads, I am inclined to believe there may be something more than a pullback brewing underneath this market.

For OAS, I am looking at the Bank of America Merrill Lynch US High Yield Master II OAS (HY OAS). For CDS spreads, I am using S&P/ISDA CDS U.S. High-Yield Index (CDS).

 

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