Why the fall in high yield bonds was a surprise

Market Realist

Must-know: Is investor fatigue setting in? (Part 3 of 5)

(Continued from Part 2)

However, high yield is somewhat more surprising. High yield is often thought of as the most “equity-like” segment of the bond market.

Good news on the earnings front and a strengthening economy usually translate into support for high yield bonds. In addition, default rates on high yield bonds are low.

Market Realist – High yield bonds like the SPDR Barclays Capital High Yield Bond ETF (or JNK) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) are riskier assets compared to investment grade bonds (AGG) and straight Treasuries (TLT). Being far out on the risk spectrum of fixed income instruments, high yield bonds display equity like characteristics—showing a correlation of as high as 0.74 with U.S. equities (SPY). It has been observed that as U.S. equities (IVV) increase, spreads on high yield bonds (HYG) tighten and indicate an increase in the risk appetite of investors.

Market Realist – The previous graph shows the correlation of the S&P 500 with high yield bonds (HYG). The graph shows that U.S. equities and high yield bonds moved in step with one another until June, 2014. However, a surprising variance in trend can be observed since the end of June. While the equities continued to increase, investors sold off high yield bonds widening spreads by as high as 13%. Some analysts consider a divergence in high yield bonds and equities to be an indicator of an impending sell-off in the equity markets.

Read the next part of the series to understand the extent of the fall in high yield bonds.

Continue to Part 4

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