A tsunami of selling rolled into the high yield ETF market today. While the market has been weaker since the end of May and the coming conclusion to QE2, today's market action in the high yield sector was quite surprising – record setting actually.
Watching trading in the junk bond ETFs, notably iShares iBoxx $ High Yield (HYG) and SPDR Barclays Capital High Yield (JNK), it appears that there was massive dumping or de-leveraging of High Yield bond ETFs by institutional investors. See charts and volume below.
For iBoxx $ High Yield (HYG), the index closed down -1.78% for the day and closed almost 2.5% below its indicative value of 90.20 at the market close. Volume exploded on HYG with 7.1 million shares traded equaling $636 million of junk. This is the record day of volume for HYG. This exceeds the 6.6 million shared dumped on the flash crash day of 2010 and represents the single largest trading day in market volume and market cap since the inception of HYG This represented almost six times the volume traded on Wednesday. The yield on HYG finished at 8.05%.
Volume was fairly normal in the morning and then the tsumani of junk selling started around 11:00 am.
Looking at SPDR Barclays Capital High Yield (JNK), we see the same story. The index closed down -1.87% for the day and closed almost 2.3% below its indicative value of 39.69 at the market close. Volume also exploded on JNK with 16.62 million shares traded. This was the single highest volume for JNK and exceeded the 12.5 million shares traded on the flash crash day of 2010. The record trading volume of JNK also represented over $650 million in junk bonds with a combined total of over $1.2 billion dumped on the market in a half day of trading. The yield on JNK finished the day at 8.6%.
For JNK, the daily trading volume looked similar to HYG, with the tsunami of selling starting around 11:20 and continuing into the close.
For the little guy, one has to sit back and wonder what happened in the world for a massive amount of dumping to begin on a single day. We speculate that this is the de-leveraging of a large or group of institutional investors that leveraged up with QE2. With QE3 out of the picture and rates soon to rise without the heavy hand of Fed buying, perhaps the large sellers were getting out of the way of rising interest rates coming down the track. Or is it the fear of worsening economic conditions that will put pressure on the non-investment grade sector? With default rates at very low levels, we suspect it is the end of QE2 and the unwinding of massive leverage by some big fish.
For those savvy investors playing the short side of the high yield market using ProShares Short High Yield (SJB), they looked smart for a day with the ETF up 1.68%. Actually, they have been right the start of June.
The question going into Friday’s option expiration day is whether the spreads between the index and the indicative with hold, or whether the ETF was leading the index or the massive tsunami of selling caused a dislocation that will exist for a short period of time.
One thing is sure, the summary of economic reports over the last month have become less positive and raised concerns of an economic slowdown. The question is whether the slow down is temporary due to high oil prices, Japan economic problems and the continuing game of chicken between the White House and Congress.
We do know that come July, the Fed will be done with it efforts to keep rates at record lows. Perhaps this was the first shot across the bow that rates are soon to rise and that investors are getting off the tracks as rates reset higher. For patient investors looking to put cash to work, the junk selling tsunami will create an opportunity some time down the road at a higher yield than could be earned in May. For those still holding high yield, It may be too late to sell. Time will tell.
Longer term, we continue to believe that high yield is the sweet spot of the fixed income market and will reward investors with a monthly dividend. Continue to watch high yeild as a leading market sentiment indicator. Without high yield, it is difficult for the equity markets to move higher (if they can find a bottom).