It’s a familiar refrain: High-yield corporate bonds are in a speculative bubble.
Now portfolio managers bearish on junk bonds are putting their money where their mouth is by shorting high-yield bond ETFs. [High-Yield Bond ETFs Can’t Shake Bubble Talk]
“Bets against the largest exchange traded funds investing in junk bonds have risen to their highest in five years, the latest sign investors are preparing for a sell-off in high-yield debt,” the Financial Times reports. “Short interest on junk bond ETFs run by BlackRock and State Street has grown rapidly in recent weeks and touched its highest levels since October 2007.” [Is the High-Yield Bond ETF Rally Really Over?]
The iShares iBoxx High Yield Corporate Bond (NYSEArca: HYG) and SPDR Barclays Capital High Yield Bond (NYSEArca: JNK) are the largest junk debt ETFs. [Junk Bond ETFs Would Get Hit by Rising Interest Rates]
Investors are taking on more credit risk to generate yield with the Federal Reserve committed to keeping short-term rates low to stimulate the economy. Junk debt ETFs have become a favorite vehicle for buying a basket of high-yield bonds with one trade and low costs.
The buying spree in junk bonds has pushed yields down to record lows, although credit spreads between high-yield debt and Treasuries haven’t gotten out of hand by historical measures. Yet there are lingering concerns investors could get burned if interest rates or corporate defaults rise.
“My reading of the evidence is that we are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit,” said Fed Governor Jeremy C. Stein in a CNBC.com report.
PIMCO Total Return ETF (NYSEArca: BOND) manager Bill Gross is also warning of frothy conditions in corporate debt.
“Corporate credit and high yield bonds are somewhat exuberantly and irrationally priced,” Gross wrote in a recent commentary. “Spreads are tight, corporate profit margins are at record peaks with room to fall, and the economy is still fragile.”
iShares iBoxx High Yield Corporate Bond
Full disclosure: Tom Lydon’s clients own HYG and JNK.