High-Yield Bond ETF Pullback a Warning Signal for Equity Bulls?

ETF Trends

The largest ETF tracking high-yield corporate bonds was down Wednesday for the fourth straight session from a multiyear high, unnerving bullish stock investors and those who have piled into junk debt funds recently.

The $16.3 billion iShares iBoxx High Yield Corporate Bond (HYG) slipped 0.5% before the Federal Reserve statement while the $13 billion SPDR Barclays High Yield Bond (JNK) was down by a similar percentage on above-average trading volume.

Many analysts keep a close on high-yield bonds to gauge risk appetite and the health of credit markets. Weakness in junk debt often presages downdrafts in stocks.

The two largest high-yield ETFs were among the top-selling funds last year. HYG pulled in $4.5 billion in 2012 while JNK added $3 billion in fresh cash as fixed-income investors took on more risk to boost yield in a low-rate market for bonds.

The junk debt ETFs are currently paying 30-day SEC yields of about 5%.

Some investors and advisors are using high-yield bonds as an equity proxy after the financial crisis, said Josh Brown at The Reformed Broker blog in a post earlier this month. “[I]t’s also something I’ve seen other financial advisors doing as a half-way measure toward coaxing their risk-averse clients off the sidelines without putting them into a higher equity weighting,” he wrote. [Are High-Yield Bond ETFs Overvalued After Big Run?]

Investors piling into junk bonds have pushed yields to all-time lows. “Every time junk bonds look like they have no more room to gain, they gain some more,” reports Michael Aneiro at Barron’s.

Still, some analysts point out that high-yield spreads relative to Treasuries aren’t flashing bubble-like conditions at the moment.

“Yields have been pushed down by a highly aggressive central bank policy, with the result that yield-oriented investors have been pushed into owning lower-rated credits,” said Fran Rodilosso, fixed income portfolio manager at Market Vectors ETFs, in a recent note. “As a result, the yields on riskier debt are as low as they have ever been. But the credit spreads, the difference between the yield on a high yield bond and a Treasury security, are actually closer to their historic average.”

Junk bond credit spreads are not anywhere near all-time historical lows, which is one reason why Marc Prosser at Forbes argues that high-yield bonds can continue to rally in 2013. He also cites corporate default rates near all-time lows, yield-starved bond managers leveraging up, and the fact that everyone thinks there is a bubble in junk bonds.

Yet “effective yields” in junk bonds are at multiyear lows, Kimble Charting Solutions points out. The effective yield measures a bond’s yield when interest payments are reinvested. Also, high-yield funds and the S&P 500 are hitting key technical resistance levels at the same time, according to Kimble.

The bottom line is that investors should keep a close eye on high-yield bond ETFs for any additional warning signs.

iShares iBoxx High Yield Corporate Bond

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Effective yield chart source: Kimble Charting Solutions

Full disclosure: Tom Lydon’s clients own HYG and JNK.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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