Why It's Time to Consider Junk Bond ETFs

The rally in so-called “junk bonds” and junk bond ETFs has been one of the market’s strongest since mid-July.

Those businesses representing the biggest risk are the ones that are really basking in the glow of July’s rally in the S&P 500.

The winning stocks have been the companies with a rating of BB or lower, also known as “high-yield junk,” explain Jennifer Alban and Rodrigo Campos for Reuters. Shares prices for junk companies are up between 21%-29% as of Aug. 4. By comparison, investment-grade companies with a BBB rating and higher are up 9.5%-19.25% for the same period.

Part of the reason for this rally is that the most beaten-down areas and sectors tend to have the furthest to go in a recovery. Companies with high credit ratings have a tendency to weather challenged markets better, so when a rally takes place, they usually don’t skyrocket.

Some analysts believe that the recent junk rally can’t sustain itself unless higher quality companies join in on the growth sooner rather than later. The higher-rated companies have less growth potential, though, so their earnings prospects may need more time to kick in.

Have a strategy and a stop-loss in place to protect yourself when the trend shows signs of ending.

In the meantime, here are some ways you can get this exposure with ETFs:

• iShares iBoxx $ High Yield Corporate Bond (HYG): up 10.2% year-to-date

• iShares iBoxx $ Investment Grade Corporate Bond (LQD): up 0.7% year-to-date

• SPDR Barclays Capital High Yield Bond (JNK): up 24.7% year-to-date

For full disclosure, Tom Lydon’s clients own shares of LQD.

Comments

[Battlebots:]

Can you consider HY without delving into expected default and recovery rates? Or is this just a momentum play?

Aug 12 09:59 AM

[Mad Hedge F...:]

fghj. At the beginning of the year I was wildly bullish about junk bonds, and recommended a covey of ETF’s, including the Lehman High Yield Bond Fund (JNK), the PS Corporate High Yield Bond Fund (PH, and the iShares iBoxx Fund (HYG) (see my report ). At the time, fears about The End of The World triggered cascading margin calls and distress liquidation that saw tidal waves of paper dumped into a no bid market. Some lesser credits traded with yields at 2,500 basis points over Treasuries. JNK is now 54% up from the March lows, and the others have done as well. Once the Great Depression II was taken off the table, the scramble for yield by hedge funds couldn’t have been more awesome. The average spread over Treasuries has been cut from 1,800 basis points to a mere 1,000, which was where spreads maxed out in the 1990 and 2002 recessions, and could be the new “normal.” This is against a 20 year average junk spread of 600 basis points, and only 100 basis points seen at the ultra frothy 2007 peak. The good news is that falling junk yields may eventually force tight fisted commercial banks to ease up on the supply of conventional loans, which is restraining a real economic recovery. Gains on junk from here may be limited. Emerging market corporate issuers inundated this market in Q2, some dubious borrowers are starting to sneak back in, and the rollover calendar going forward is truly enormous. There are too many better fish to fry. I’d take the money and run.

Aug 12 11:35 AM

[claudio.lan...:]

This article is so late that is actually an insult. Anyone following anything knows this is not the time to be buying any of the names listed in the article. Perhaps the author just wants to keep posting article for some reason. Certainly this article was not worth time it took to read it and even less because I have wasted my time to write this post.

Aug 13 10:38 AM

[LIVE FREE O...:]

Agreed.

Mad Hedge & Claudio have hit the nail on the head.

This is beautiful "softball" pitch (short) waiting to be hit out of the park.

LQD is a great example of how to get creamed if you buy long now. Last year at this time LQD was around a 100 (currently at 102). Within weeks LQD fell of the cliff. It will fall of the cliff again here shortly. Buying now is a recipe for disaster.

Disclosure - I was purchased March $93 puts on LQD yesterday (there was over 11,000 puts placed yesterday for March $93).


On Aug 13 10:38 AM [e-mail] wrote:

> This article is so late that is actually an insult. Anyone following
> anything knows this is not the time to be buying any of the names
> listed in the article. Perhaps the author just wants to keep posting
> article for some reason. Certainly this article was not worth time
> it took to read it and even less because I have wasted my time to
> write this post.

Aug 13 11:01 AM