In her Humphrey Hawkins testimony earlier in the month (still July as I pen this missive) Ms Yellen averred that valuations on junk bonds were “stretched”. Today the market heeded her words and junk tumbled.
Via the WSJ:
Investors retreated from risky corporate debt on Thursday, sending prices tumbling and deepening fears of an end to a long rally in junk bonds.
U.S. junk-bond funds registered a $1.48 billion weekly outflow, their third consecutive decline, fund tracker Lipper said.
The latest declines reflect fresh signs that U.S. growth is picking up in earnest, a trend that many global bond managers expect to eventually prompt a Federal Reserve interest-rate increase that would likely squeeze bond returns.
Also rattling investor sentiment: fears that gains in riskier assets have outpaced the improvement in the outlook for global growth and the health of consumer finances.
Traders said the developments underscore the market’s vulnerability following a multiyear rally that this year took the yield on major junk-bond indexes to record lows. Yields fall when prices rise.
Investors on both sides of the Atlantic had flocked to corporate debt rated below investment grade to capture income with short-term interest rates near zero.
“The easy trade is over,” said Alan Gayle, who oversees about $350 million as director of asset allocation at RidgeWorth Investments. “It’s a trade-off between volatility and returns.”
Mr. Gayle said that he has been paring his allocations to high-yield bonds in recent months, to about 15% from 17%. He said the shift reflected the narrowing in the spread, or yield premium over risk-free U.S. Treasury debt that investors receive in buying riskier bonds.
The latest selloff came on a day when markets around the globe slumped, following a round of subpar corporate earnings reports and downbeat news from around the globe.
U.S. high-yield issues on Thursday declined across the board.
Bonds of media-and-entertainment company Clear Channel Communications Inc. due in January 2018 were down 2.5 cents on the dollar to 91.5 cents, for a yield of 13.141%. On Wednesday, they yielded around 12%.
The pullback hasn’t been limited to the U.S. The average yield on euro-denominated junk bonds is 4.04%, 0.3 percentage point higher than at the end of June, according to a Markit index. That has left euro junk bonds facing their first negative total return, reflecting price changes and interest payments, since June of last year, Markit data show.
“There is not much of a cushion of yield to protect investors from an increase in volatility,” said Chris Iggo, chief investment officer of AXA Investment Management’s fixed-income unit.
The retreat came on the heels of the latest bullish data on U.S. economic growth.
On Thursday, claims for unemployment insurance in the last week came in slightly better than expected, at 302,000, while the prior week’s figure was revised down to 279,000, a 14-year low. On Wednesday, data showed the U.S. economy expanded by 4% in the second quarter, topping estimates.
Shares of the largest exchange-traded fund that tracks the high-yield market, the $12 billion iShares iBoxx $ High Yield Corporate Bond ETF, HYG -0.82% slumped 0.8% Thursday, extending its decline to 2.9% in July. The ETF has been highly sensitive to rate fears in the past and hadn’t seen as large a monthly tumble since May 2013, when Fed officials began hinting that the central bank would pare back its easing measures.
Many investors and policy makers have remarked in recent months on the placidity of markets, with some expressing concerns that rising prices and low trading volume could point to a complacent mind-set in which traders overlook significant risks.
Fed Chairwoman Janet Yellen said last month in prepared remarks in the Senate that low interest rates “may provide incentives for some investors to ‘reach for yield,'” noting that the valuations of low-rated corporate debt “appear stretched.”
Investors in July yanked more than $5 billion from junk-bond mutual funds and exchange traded funds, according to Lipper. That is the most for any month since those funds’ record monthly outflow of $15.6 billion in June 2013, Lipper said.
While total returns on U.S. junk bonds have reached 4.7% this year, the bonds had lost 0.72% in July as of Wednesday, according to data from Barclays PLC. That puts junk bonds on pace for the worst monthly performance since May 2012.
“This kind of volatility is what the market was missing for quite some time,” said Brian Hessel, chief operating officer at hedge fund Global Credit Advisors LLC, which has about $700 million in high-yield debt. He said the market felt like the “type of environment where the outflows could continue.”