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Business Outlook Could Challenge Junk Bond ETFs

This article was originally published on ETFTrends.com.

High-yield corporate bond ETFs, including the iShares iBoxx $ High Yield Corp Bd ETF (HYG) and the SPDR Barclays High Yield Bond ETF (JNK) , are rebounding this year, but some analysts are urging caution with the resurgent group.

JNK seeks to provide investment results that correspond generally to the price and yield performance of the Bloomberg Barclays High Yield Very Liquid Index, which is designed to measure the performance of publicly issued U.S. dollar denominated high yield corporate bonds with above-average liquidity. HYG tracks the investment results of the Markit iBoxx USD Liquid High Yield Index, which is comprised of high yield U.S. corporate bonds that have less than investment-grade quality.

Although junk bonds struggled last year, many analysts were bullish on the asset class heading into 2019.

“The valuation of high-yield bonds currently receives support from expectations of corporate earnings growth into 2020 and a related benign outlook for defaults,” said Moody's Investors Service. “Though S&P 500 earnings per share are likely to dip year over year in 2019’s first quarter, this metric is expected to post yearly beginning with the second quarter and well into 2020.”

Monitoring Economic Activity

A spike in corporate defaults could be exactly what causes the party to end for all markets. The amount of corporate indebtedness has reached unprecedented levels, which has made these companies more susceptible to rising interest rates or worse, a recession. Fortunately, data suggest default rates are benign, for now, but economic activity could hold the key to junk bonds' near-term fortunes.

“Early indications hint of an uninspiring pace of first-quarter 2019’s real consumer spending,” according to Moody's. “For example, January 2019’s unit sales of cars and light trucks in the U.S. fell by 5.1% from December 2018’s pace on a seasonally adjusted basis to 16.6 million annualized units. January’s monthly drop was the deepest since the 8.1% plunge of May 2011, while January’s seasonally adjusted annualized sales pace was the lowest since the 16.4 million units of August 2017.”

Fortunately for junk bonds and the corresponding ETFs, expectations are low that the Fed will raise interest rates this year.

“In summary, the flatness of early 2019’s business activity preserves the possibility of yet lower Treasury bond yields. It’s for good reason that the futures market assigns merely a 5% likelihood to fed funds ending 2019 above their current 2.375% midpoint,” notes Moody's.

For more information on the fixed-income market, visit our bond ETFs category.

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