Junk Bonds Lag Behind Stocks: Is It Time to Buy the Dip?
Amidst a surge in the stock market, high-yield bonds, also known as junk bonds, are trailing behind, sparking questions about whether now is a good opportunity for investors. The recent rise in interest rates has made junk bonds less attractive, as they become riskier, with higher yields potentially needed to compensate for the increased risk.
While high-yield bonds generally move in tandem with stocks, recent market fluctuations have introduced a divergence. "High-yield bonds are seen as kind of a de facto stock, at least for the bond market," explains Craig Johnson, a portfolio manager at Piper Jaffray. However, the recent rise in rates has impacted junk bonds, causing them to lag behind the surging stock market.
This divergence is causing some to wonder if the recent trend in high-yield bonds warrants a closer look. Johnson, along with Zack, a technical analyst, discussed this on CNBC’s "Trading Nation," acknowledging that the recent rise in interest rates has been a factor. "It’s been a very strong year after a very weak year, and we’re kind of back to where we were a few years ago," Johnson said, referring to the performance of the High Yield ETF (HYG).
While the recent 20-day surge in interest rates has influenced the performance of junk bonds, some argue that it’s a temporary blip in a broader trend. "Charts matter because it’s a great discounting mechanism into the psychology of what’s happening with investors in these markets," Johnson points out. He drew attention to the ten-year correlation between the S&P 500 and HYG, highlighting periods of negative correlation that often presented opportunities to buy into the HYG.
This sentiment was echoed by Zack, who acknowledges the possibility of a new paradigm shift post-Trump’s election but ultimately sees strong value in high-yield bonds. "I think HYG at these levels, I think high-yield at these levels offers really good yield relative to risk," Zack said. He cautions, however, against expecting the historical correlation between stocks and HYG to hold up completely in this new environment.
In conclusion, the divergence between high-yield bonds and stocks has presented an intriguing opportunity for investors. While the recent rise in interest rates has impacted the junk bond market, some analysts see it as a temporary blip and believe that the current drop may present an attractive entry point for long-term investors seeking a higher yield. As the market adjusts to the new political and economic landscape, both the chart patterns and the underlying fundamentals of the high-yield bond market will be crucial factors to consider.
High-Yield Bonds Lag Behind Stocks Amid Rising Rates: Is This a Buying Opportunity?
The recent surge in interest rates has left high-yield bonds (also known as "junk bonds") trailing behind stocks, raising questions about their future prospects. While high-yield bonds are often considered a de facto stock in the bond market, their recent performance suggests a potential shift in the market dynamics. This divergence raises the question: is this a temporary setback or a sign of a larger trend?
Key Takeaways:
- High-yield bonds have historically moved in tandem with stocks, but recent interest rate hikes have created a disconnect.
- The correlation between high-yield bonds and stocks may be breaking down due to the unprecedented political and economic landscape following the recent election.
- Despite the recent underperformance, high-yield bonds still offer attractive yields relative to their risk.
- The market is experiencing a paradigm shift, making historical correlations less reliable in predicting future performance.
Examining the Disconnect: High-Yield Bonds vs. Stocks
The recent divergence between high-yield bonds and stocks is a significant development in the market. Traditionally, high-yield bonds have exhibited a strong positive correlation with stocks, moving in the same direction. This correlation is driven by factors like investor sentiment, economic growth, and risk appetite. However, the recent rise in interest rates has disrupted this dynamic.
"High-yield bonds are seen as a sort of de facto stock in the bond market," explains Craig Johnson, a technical analyst at Piper Jaffray, during a recent episode of CNBC’s "Trading Nation." "But a part of the rise over the past month has left [junk bonds] in the dust."
Johnson attributes this divergence to the anticipation of higher interest rates. "As rates go up, junk bonds become less attractive, and potentially riskier," he explains. "They may have to pay higher rates to compensate for the added risk."
Looking Back to Understand the Present
To understand the current situation, it’s crucial to examine the past. As Johnson notes, the period between 2015 and early 2016 was a difficult time for high-yield bonds. The collapse of the energy and commodity markets led to widespread fears of defaults.
However, those fears largely didn’t materialize, and high-yield bonds rebounded strongly in 2016. This suggests that the current underperformance may be a temporary blip in a larger positive trend.
The Role of Charts and Technical Analysis
Technical analysts, like Craig Johnson, rely heavily on charts to identify potential trends and trading opportunities. Charts are essentially a graphical representation of historical market data, which can help pinpoint patterns and signal future direction.
Johnson argues that charts are valuable because they "discount the psychology of what’s happening with investors in these markets." He highlights the historical correlation between the S&P 500 and the HYG (iShares iBoxx High Yield Corporate Bond ETF), noting that periods of negative correlation have historically presented attractive buying opportunities for high-yield bonds.
A New Paradigm Shift?
Zack, a fellow analyst on "Trading Nation," argues that the recent political and economic upheaval – particularly the unexpected victory of Donald Trump – has created a new paradigm. He suggests that historical correlations may be less reliable in predicting future market behavior.
"I would say that a lot of these correlations may begin to break down because of the ways in which, and the reasons why, equities are moving," Zack remarks. "Whether or not we’re going to have a rotation from bonds into equities, I think high yield at these levels offers good yield relative to the risk."
While acknowledging the potential shift in market dynamics, Zack emphasizes that the high yield still presents appealing yields relative to risk.
Conclusion: A Buying Opportunity or a Cautionary Tale?
The recent disconnect between high-yield bonds and stocks has sparked debate among market analysts. While some view the current situation as a buying opportunity, others remain cautious.
The unprecedented changes in the political and economic landscape have created a high degree of uncertainty, making it difficult to predict the future direction of high-yield bonds. Ultimately, investors must carefully assess their risk tolerance and invest with a long-term perspective, recognizing that the market is constantly evolving.
As the market continues to adjust to the new political landscape, and interest rates rise, investors must remain vigilant and closely monitor the performance of high-yield bonds. The recent underperformance may be a temporary blip, or it could be a sign of a more fundamental shift in the market. Only time will tell how this story unfolds.
