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Tuesday, February 5, 2013

The WSJ Forgets About Dividends and Total Return...And Misses the Reason for the Move In High Yield Bonds

In the never ending effort of financial journalists to read the tea leaves of short term market moves, the analysis is say the least shoddy. Take the WSJ's effort today to find some major turning point in short term movements to HYG the high yield bond ETF.

The iShares iBoxx $ High Yield Corporate Bond exchange-traded fund (HYG) suffered its seventh-straight loss Monday, closing at its lowest level since Dec. 28. That is the longest losing streak for the fund since a nine-session stretch ending April 10, 2012.
The HYG slumped 0.4% to $93.09 Monday and has shed 1.9% since peaking at a 4 1/2-year high of $94.88 Jan. 24. The S&P 500 lost 1.2% Monday to 1495.71, after having closed at its highest level in more than five years Friday
Seems like the WSJ forgot about something called dividends and total return. Investors capture total return not price only return. So even though HYG closed at its lowest level since Dec 28, HYG investors have had a total return of 

Furthermore the WSJ suggests that the move in HYG reflects concern about the riskiness of the bonds in terms of credit risk
While the HYG’s fall could be seen by some as cash potentially leaving bonds for riskier assets–potentially a bullish sign–equity investors shouldn’t count on that money finding its way into higher-risk stocks.
Nearly 100% of the HYG’s holdings are corporate bonds from companies like Sprint, Chrysler, and Ally Financial with credit ratings below investment grade, also known as junk bonds. Given their risk profile, high-yield bonds tend to trade a lot more like stocks than investment-grade bonds. Over the past two years, the correlation coefficient between the HYG and the S&P 500 is 0.89, where 1 indicates perfect correlation. Meanwhile, the correlation between the HYG and the iSharesBarclays BARC.LN +1.29% 7-10 Year Treasury Bond ETF (IEF) is 0.27.
While the HYG’s recent slide is no guarantee a stock selloff is imminent, bulls who have enjoyed a nice run over the past few months may not want to tempt fate.
While the point about long term correlations is correct, it is certainly not the explanation for the selloff in HYG, NYG an intermediate term high yield bond fund sold off because of interest rate changes. All intermediate term bond ETFs sold off during the period. In fact HYG has performed better than investment grade intermediate term corporate bonds (LQD) and intermediate term treasuries (IEF). So in fact high yield investors because of the higher yield did better than other bond investors in intermediate term .

Further proof that it was the interest rates and not a change in perception of credit risk that drove the price change can be seen in the performance of the short term high yield bond ETF SJNK. If the downward move was driven by credit risk and not interest rate risk one would expect intermediate term(HYG) and short term (SJNK) high yield bond funds to move in tandem. But the exact opposite happened...sjnk went up when intermediate term investment grade bonds and intermediate term treasury bonds went down. In other words it was the interest rate risk not the credit risk that explains the declines in intermediate term investment grade and treasury bonds...and the underperformance of intermediate term vs. short term high yield bonds.

Bar charts top = total return bottom = volatility Dec 28,2011 – Feb 4, 2012

 GROWTH OF $100,000 Dec 28 2012 –Feb4, 2012 (HYG gold, SJNK blue  LQD black IEF green)

GROWTH OF $100,000 (HYG gold, SJNK blue  LQD black IEF green)

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