High Yield Bond Returns YTD Signal Solid 2012 Performance

Feb.29.12 | About: SPDR Barclays (JNK)

Recently I published an article on the January Effect in high yield bonds, which demonstrated that the signaling effect in high yield bonds from early year returns was in fact much stronger than the fabled calendar effect in equities. In the study, returns on high yield bonds in January were significantly higher than all other months while exhibiting lower variability of returns. Returns early in the calendar year in high yield bonds also strongly predict the directionality of full year returns. Given the strong start to 2012, high yield bonds should exhibit solid returns through the end of the year.

Using data from the Barclays High Yield Bond Index (replicated approximately through ETF JNK), the returns through February of the last seventeen calendar years have correctly predicted the directionality of the full year return. In the available full year dataset published since 1984, only one year, 1994, saw returns through February that did not have the same sign as the full year results (January-February 1994 saw a 1.9% return while full year returns were -1%).

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Breaking the 28 years of data into quartiles and sorting the results ascending by the returns of the first two months also illustrates the strong amplitude of this effect in addition to the predictability.

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This calendar effect is not nearly as evident in equities, as proxied by the returns of the S&P 500 (NYSEARCA:SPY) over a matched duration. In five of the last seven years, and eight different years over the sample period, the returns of the first two months have had a different sign than the returns for the full year. The year that saw equities jump off to their best start was 1987, which saw much lower full year returns due to the fourth quarter stock market crash in that year. The year that got off to the worst start was 2009, which ended up being a strong year for the markets as returns bottomed in March and headed substantially higher for the full year.

Expect returns on high yield bonds to remain solid in 2012 given the strong calendar effect as investors who have missed some of the spread tightening in the high yield credit market year-to-date chase yields to even lower levels.

Disclosure: I am long SPY.