Divergences Between Equities, High-Yield Bond ETFs

Amid a spate of energy issuer defaults and downbeat performances by CCC-rated issues, tensions are running high in the U.S. junk bond market. Last year, the iShares iBoxx $ High Yield Corporate Bond ETF HYG and the SPDR Barclays High Yield Bond ETF JNK, the two largest junk bond exchange traded funds by assets, fell an average of 5.9 percent.

Add to that, ETFs such as HYG and JNK have been plagued by abundance of issues from the downtrodden energy and materials sectors. Those groups accounted for the bulk of high-yield defaults last year.

Currently, investors are displaying mixed emotions about high-yield bonds and the aforementioned ETFs with some seeing more trouble ahead while others believe a buying opportunity is afoot. Notably, stocks and high-yield credit have recently been diverging.

“We’ve seen equities and high yield diverge in recent months. After the late summer swoon brought on by the surprise Chinese devaluation of the yuan, US stocks rebounded to close the year above par, before falling victim once again to continued pressures from energy markets and concerns over global growth as the new year got underway,” said State Street Vice President David Mazza in a recent note. 

Ongoing issues for CCC-rated bonds have caused spreads to widen as bonds with those ratings trade at their highest yield spreads to Treasurys since the financial crisis. Recent data indicate the bulk of high-yield issues trading at distressed levels hail from, not surprisingly, the natural resources and oil and gas arenas. Twelve industry groups see less than 10 percent of their respective high-yield bond issues trading at distressed levels.

“Current default rates have reached their highest level since 2009, with 102 companies around the globe failing to meet their debt obligations. These defaults have largely been contained within commodity-related sectors, but this trend should be closely monitored, especially if defaults spread beyond these troubled sectors. As of now, after stripping out the energy, metal and mining firms, the forecasted 2016 default rate for high yield issuers is 1.5%, which is below Fitch’s non-recessionary average of 2.1%,” said Mazza.

Year-to-date, five of the top 10 asset gathering ETFs are fixed income funds, but investors have pulled about $821 million combined from HYG and JNK. The pair pulled in over $2.6 billion combined last year.