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Must-know: This week high-yield bonds didn't follow stock returns

Must-know: This week high-yield bonds didn't follow stock returns (Part 1 of 7)

Why high-yield bonds didn’t follow the path of stock returns

Primary and secondary markets update for high-yield debt

Returns on high-yield (HYG) debt usually bear a higher correlation to stock market (SPY) returns rather than the returns on other forms of debt like U.S. Treasuries and investment-grade corporate bonds (LQD). When the economy is on an expansionary trajectory, the spreads between investment-grade and non-investment grade bonds usually decline, due the belief that high-yield debt issuers would have an improved ability to service their debt obligations and delinquency rates would be lower.

Part 1Enlarge Graph

Comparing returns for stocks and junk-rated debt

The previous chart shows how high-yield debt returns have showed a stronger correlation with the S&P 500 Index in 2013 and 2014 year-to-date (or YTD), compared to Treasuries and investment-grade debt. Last week proved to be the exception to this because upbeat corporate earnings didn’t result in upwards price movement for both stocks and junk-rated debt. Markets’ risk perceptions for high-yield bonds outweighed any upside considerations that usually result from an improving economy and better-than-expected corporate earnings.

The S&P 500 Index (SPY) gained 0.54% over the week ending July 18 on corporate earnings releases for 2Q14. Tech firms like Google (GOOG) and financial sector firms like Goldman Sachs (GS) and JPMorgan reported earnings that came in ahead of analyst estimates.

However, the spread between high-yield debt and Treasuries widened by 17 basis points. Yields on high-yield debt increased as well by 17 basis points, leading to negative returns for high-yield bonds. The price of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) fell by 0.64% over the week.

You’ll find a more detailed yields and spreads analysis in Part 4 of this series.

Geopolitical risks and high-yield bonds

The crash of the Malaysian airliner over war-torn Ukraine last Thursday increased risk perceptions among market participants. Volatility, as measured by the VIX, or the index commonly known as the “fear factor,” increased by 32% on Thursday, July 18 to 14.54—its highest level in over three months.

Unrest in Gaza also contributed to geopolitical concerns among investors. These concerns caused a flight to safer investment-grade bonds. Investment-grade corporate bond mutual funds recorded positive flows of $1.6 billion last week as opposed to negative flows of $1.68 billion in high-yield bond funds.

Fed Chair Janet Yellen comments on high-yield bond funds

Investors in high-yield bond funds were also spooked by increased concerns raised by policymakers over signs of froth in speculative bonds and leveraged loans.

On July 16, Fed Chair Janet Yellen spoke of heightened risks in the leveraged loans and speculative-grade bonds segments at her semi-annual congressional testimony. She said that valuations appeared stretched and underwriting standards had fallen. The Fed and other regulatory agencies would be keeping a close eye on developments in this area.

High-yield primary market debt issuance decreases

Issuance levels by corporates in the high-yield and leveraged loans primary markets slumped by 24% and 73%, in the week ending July 18 to $5.13 billion and $4.4 billion, respectively (Source: S&P Capital IQ/LCD). You’ll find more details about primary market activity in the following section.

 

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