The Canary in the Coal Mine?

Chris Dieterich of the Wall Street Journal reports, Are High-Yield Bonds the Canary in the Coal Mine?:
Keep your eye on junk bonds.

An improving global economy and ever-present demand for income has supported high-yield bonds all year. Valuations became stretched, but investors held their noses and bought them anyway, accepting some of the smallest rewards for owning risky debts in a decade because, well, what’s the alternative?

But junk-bond indexes have hit a rough patch, even as the major U.S. stock benchmarks have continued to grind higher. Take the $19 billion iShares iBoxx $ High Yield Corporate Bond ETF, which is down 1.4% over the past two weeks. Wednesday’s drop, 0.4%, was its worst in over a month and cut the price of the ETF, which trades under the ticker HYG, to the lowest since August.

The recent drop sent the ETF knifing below its so-called 200-moving average, viewed by technicians as a long-term market threshold for market momentum. This level has marked HYG's bottom half a dozen times since the middle of last year.

Meantime, junk bond “spreads” perked up from the tightest levels since 2007. The extra premium high-yield bond investors demand to own riskier bonds in lieu of Treasury notes rose to 3.57 percentage points Tuesday, up from 3.38 two weeks ago.

And yet, over in the equity market, the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite Index all closed at fresh highs on Wednesday.

While losses have been relatively small, the divergence between falling high-yield bond prices and U.S. stocks at records is rare. Only one other time since HYG launched in 2007 has the S&P 500 hit an all-time intraday high, as it did Tuesday, on the same day that the HYG fell to its lowest level in at least a month, according to Jason Goepfert, founder of Sundial Capital Research.

Some traders are girding for worse. Volume in protective HYG put options Wednesday jumped to the highest since June, according to Trade Alert. Buyers of put options generally profit from additional declines.

Stocks and junk bonds have moved closely together this year so what comes next could be telling. Will buyers swoop and buy the junk-bond dip, or will the selling extend to other risky assets?
Dani Burger of Bloomberg also reports, High-Yield Funds Go Bananas as Junk-Bond Rout Worsens:
As U.S. markets swim in sea of red, trading in the largest high-yield exchange-traded funds has skyrocketed to dizzying levels.

The iShares iBoxx High Yield Corporate Bond ETF, Blackrock Inc.’s $18.7 billion fund, saw volume spike over five times higher than its average level at 1:19 p.m. in New York, according to data compiled by Bloomberg.

At more than 23.8 million shares, trading in the largest junk-bond fund has already surpassed its one-day average of 11 million for the past year -- outpacing volume notched in August amid saber-rattling between the U.S. and North Korea.

The delay in the Republican tax plan has spurred a sharp selloff across growth-sensitive assets, with the S&P 500 heading for its worst slump since August.

The BlackRock ETF is at its lowest level since March, set for its third consecutive day of declines.

For the $12.6 billion SPDR Bloomberg Barclays High Yield Bond ETF, one or a few of the larger players account for an outsize share of trading, with volumes more than six times higher than normal for the current session. Within 30 minutes through 12:38 p.m., three block trades were executed that totaled $394 million, data compiled by Bloomberg show.
I've been closely tracking activity in the iShares iBoxx $ High Yield Corp Bond ETF (HYG) and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK).

If you look a the weekly (not daily charts), you will see there is a dip but it's not the end of the world yet and too soon to say whether a new downtrend is upon us (click on images):

Importantly, we have seen two mini dips like this before and the uptrend resumed so it's hard to tell whether this is it.

However, as Zero Hedge notes, the leaders are crashing and it's not just junk bonds. Risk assets are shaky here, especially stocks where I noted two weeks ago, it's as good as it gets.

Still, it's too early to tell whether "this is it" as we know central banks stand on guard and there are plenty of signs euphoria is creeping into markets.

It's also worth noting if there was genuine fear, US long bonds (TLT) wouldn't be selling off, they'd be rallying hard and decoupling from stocks.

That's why I caution you not to read too much in this latest hiccup in risk assets.

Having said this, I would use any selloff in US long bonds to add to or initiate a major position as I agree with those who think bond bears are wrong and rates won't rise.

I sent this article to an astute retired reader of my blog who sent me this:
Question: why is it that the financial sophisticates seem to assume that the bond market can only either go up or down and that staying flat over a long period, such as in Japan, is just not a possibility? The cited graphs in the piece you sent are surely a reminder, even if you did not need the more contemporary reminder of Japan, that having declined substantially, yields can stay down for a very long period. It’s as if they think that is just an ontological impossibility.

If it is a possibility, you can own long duration bonds without necessarily being bullish, especially as a retiree: match liabilities and hedge deflation. You just need to be not bearish and want or need the fixed income through retirement years.

BTW, in case you are interested in one retiree’s approach to the issue, I sell TLT puts to get some of my exposure. It materially reduces the volatility associated with owning it and, very importantly, capitalizes the dividend, cutting the tax rate on the coupon in half. Canadians have a great advantage over Americans in this respect, as we do not have a short-term capital gains regime.
No, we don't but every time TLT goes down and the Canadian dollar rallies, I curse my screen screaming "can't the loonie just die already?!?".

[Note: Higher oil prices due to what's going on in Saudi Arabia have hit US bonds and bolstered the loonie but we shall see how sustainable this move is.]

My reading is these are markets you need to trade actively to make serious money and you'd better pick your stocks right, which sounds easy but it most certainly isn't.

On that note, here are the winners and losers on my stock watch list this Friday (click on images):

Again, take all this with a grain of salt as stocks I track move up and down like a yo-yo but you need to really be careful here as there are no "no-brainers" in these markets.

I will leave you with a final chart of biotechs (XBI), a daily chart going back a year (click on image):

Notice the triple-bottom? It needs to hold and make new highs because if it rolls over here, and there's another bloodbath in biotechs, it doesn't bode well for technology stocks or the overall market.

Don't worry, I'm sure the Plunge Protection Team will be on it next week and euphoria will creep back into markets in no time. -;)

Hope you enjoyed this market comment, as always, please take the time to kindly donate or subscribe to this blog using PayPal on the right-hand side under my picture.

I had dinner with a former colleague and friend of mine this week who told me: "Stop giving your stuff away for free, charge money to a select few and stop being so damn nice to everyone. Those who want to continue reading you will pay and the hell with others who don't."

I'm afraid he's right but for now I'm leaving my blog open to the masses as I want to educate as many people as possible on pensions and investments. I thank all of you who support this blog via your financial contributions.

Below, Bloomberg's Lisa Abramowicz discusses junk bond jitters. Listen to her comments on why the new proposed tax bill will hurt high yield companies because roughly 40% wouldn't be able to deduct as much of their debt interest payments if this bill passes.

And CNBC contributor Mike Khouw looks at a bet against high-yield bonds.

As I stated above, it's too early to tell if there is a major junk bond rout going on or just another mini dip, especially when looking at the weekly (not daily) charts.

Still, keep your eye on high yield (junk) bonds, they may very well be the canary in the coal mine.