Asset classes react differently to credit and geopolitical crises



Asset classes react to crises

Returns on the S&P 500 Index (SPY), high-yield debt (HYG), and investment-grade debt (or LQD) as well as U.S. Treasuries (TLT) were positive in the week ending August 8. However, leveraged loans (BKLN) experienced negative returns.

Year-to-date (or YTD) returns on the S&P/LSTA U.S. Leveraged Loan 100 Index have come in at 1.93% up to August 8. For the week ending August 8, the Index decreased by 0.15%, compared to an increase of 0.33% in the S&P 500 Index.

Leveraged loans are issued on a floating rate basis. While issuers benefit when yields decline, investors are adversely affected because returns are based on prevailing market rates.

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The S&P 500 Index (SPY) was positively affected towards the end of the week due to market perceptions that the crisis in Ukraine may be easing as Russia called off military exercises near Ukraine. The Index had been down lately due to geopolitical fears in the Middle East and Russia. This may have been a correctional rally.

High-yield bonds rally

As explained in Part 1, returns on high-yield debt were positive last week. The SPDR Barclays Capital High Yield Bond ETF (JNK) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) increased by 1.03% and 1.04% over the week ending August 8.

In the previous week, junk bond yields had increased by over 50 basis points, in reaction to the Argentinian and Portuguese credit crises and overseas geopolitical risks. Last week’s decrease in yields may have been a market correction. The lower bond prices may have represented a buying opportunity for more market-savvy and risk-inclined investors. As long as the monetary policy is expected to say accommodative—a low interest rates environment—investors with a higher risk appetite would continue “reaching for yield.”

Another possible explanation for the upturn in high-yield debt markets, may be that bond mutual funds used cash for funding redemptions, staving off a bigger sell-off in high-yield bonds.

Returns on investment-grade bonds and Treasuries were positive, but for different reasons. Also, primary market conditions were vastly different. You can read about these in the Market Realist series, Overview: High-grade borrowers are upbeat about market conditions.


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