High-yield debt (junk bonds) is deteriorating significantly

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November 20, 2018 1:46pm NYSE:JNK

high yield bonds

From Sunny Oh: Stock market bulls previously took comfort in the high-yield corporate bond market’s resilience as stocks suffered their autumn swoon, pointing to their resilience as evidence of the underlying health of the corporate sector.

But with high-yield debt, or junk bonds, now slammed by an oil bear market and fears over excessive borrowing by U.S. corporations, stock buyers may no longer find solace from one of the strongest performing corners of the bond market this year. That’s according to David Rosenberg, chief economist for Gluskin Sheff, who says equity investors are having to face up to the reality that the economy’s underpinnings may be less robust than they appear.

Prior to the selloff in high-yield debt, “stock market bulls were hanging their hats on the ‘nonconfirmation’ in the credit space,” said Rosenberg, in a Monday note.

SeeWhy ‘junk bond’ resilience offers comfort to stock market bulls

As high-yield debt has taken a drubbing, yields have risen, raising the premium investors demand to own a basket of high-yield bonds over TreasurysTMUBMUSD10Y, -0.53% to 4.12 percentage points on Friday, the widest since December 2016, according to Bloomberg. A wider spread can indicate heightened investor pessimism over the high-yield market.

Meanwhile, the stock market remained under pressure Tuesday, with the Dow Jones Industrial Average DJIA, -2.00%  , the S&P 500 SPX, -1.67%  turning negative for the year.

Traditionally, fragility in junk bonds have served as the proverbial canary in the coal mine for stock market investors, in part because they signal fears about the diminishing ability of highly leveraged companies to pay back their debts as expectations for earnings and economic growth deteriorate.

So in October, when high-yield bonds held on as equities buckled, stock market bulls pointed to the robust returns in junk bonds as evidence that the U.S. expansion still had plenty of legs. But with both now falling in tandem, market bears see signs of vindication.

ReadThis recession indicator shows investors have faith U.S. growth has room to run

“The corporate debt market is beginning to ratify the weakness we have seen in equities,” said Rosenberg.

Some, however, argue against relying on high-yield spreads as a bellwether. Thanks to tax cuts, the U.S. economy is still expanding at a rapid clip, with economists polled by MarketWatch forecasting on average a 2.9% increase in GDP over 2018, and a modest slowdown to 2.7% in the following year.

“[High-yield spreads] are only one of several indicators starting to show growing concerns about a U.S. slowdown, and they’re still pretty tight historically” said Matthew Gokhman, head of asset allocation at Pacific Life Fund Advisors.

What’s more, signs of contagion in credit markets remains limited, says Gokhman, with the unwinding in junk bonds largely centered on energy companies as oil prices plummeted, leaving other sectors like consumer discretionary relatively unscathed. Energy bonds compose around 15% of benchmark high-yield indexes.

The SPDR Bloomberg Barclays High Yield Bond ETF (JNK) was trading at $34.45 per share on Tuesday afternoon, down $0.12 (-0.35%). Year-to-date, JNK has declined -4.51%, versus a -0.20% rise in the benchmark S&P 500 index during the same period.

JNK currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #2 of 50 ETFs in the High Yield Bond ETFs category.

This article is brought to you courtesy of MarketWatch.

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