Investors Are Bearish And Bullish On Junk

| About: iShares iBoxx (HYG)


Expecting spreads to blow out? Yep.

Expecting defaults to rise? Yep.

Is the space overvalued? Yep.

Time to buy? Yep.

I've talked until I'm blue in the face about the dangers lurking in high yield credit (NYSEARCA:HYG).

The cycle is not your friend here.

(Chart: Morgan Stanley)

Do you know who else isn't your friend? Dealers.

(Chart: Goldman)

What does primary dealer inventory have to do with it? Well, that's a proxy for what kind of market there is (or isn't) for the bonds that stand behind the high yield funds you're (hopefully not) invested in.

In a nutshell it means you'd better hope your fund manager doesn't face a wave of redemptions because Wall Street isn't going to play middleman. No middleman means no liquidity and limited price discovery. The only price you're going to "discover" is the firesale price the fund manager has to accept to meet redemption requests.

But that hasn't stopped anyone from piling into ETFs in the risk-on environment that's dominated sentiment since the bounce off the February lows. Here, have a look:

Click to enlarge

That's right, everything is fine. Just ask spreads (note the collapsing differential between HY and HY ex-energy):

(Chart: Goldman)

Sorry, but this is dumb money. Just look at supply:

(Chart: Goldman, my addition)

They're losing market access. HY issuance hasn't been this low in six years. Here's one reason why:

Click to enlarge

(Table: BofAML)

Sure, it starts with energy, but why wouldn't it? I mean it has to start somewhere. To say "well, it's been confined to energy so far," is like saying "well, if you strip out all of the Chapter 11s, no one has gone bankrupt." Here's Morgan Stanley:

Yes, we have just come off a multi-month period in which credit conditions have felt much better. But in a bear market, sentiment can and does swing sharply in both directions. Given the weak economic backdrop, we have always believed that it won't take much for sentiment to shift back in the other direction and credit conditions to again tighten, pushing us further along in the default cycle. Thus far, Energy has accounted for a majority of overall HY defaults, but we think it is normal for the problem sector to drive defaults early on in a cycle.

Right. But you needn't listen to me, or to Morgan, or to BofAML (whose take on the market is decidedly bearish). Why don't you ask other investors? Here are the results of BofAML's latest US credit investor survey:

Click to enlarge

(Charts: BofAML)

And the punchline:

Click to enlarge

(Chart: BofAML, my addition)

Trade accordingly.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.