Time to Jump for Junk

January 29th at 8:00am by Tom Lydon

High-yield bonds and the exchange traded funds that hold those bonds are viewed by professional investors and traders as accurate gauges of market risk appetite.

The conventional wisdom is that although bonds as an asset class are generally considered to be income generators, the opportunity for capital appreciation gives junk bonds some equity-like characteristics. If that is indeed true, some marquee high-yield bond ETFs have been laggards as U.S. equities have risen over the past year.

The SPDR S&P 500 (NYSEArca: SPY) is up more than 21% in the past 12 months, but the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest U.S. junk bond ETFs by assets, are each just over 4%. That despite fairly intimate five-year  correlations between HYG, JNK and SPY. [Junk Bond Issuance Soars]

Chart Courtesy: State Street Global Advisors

There is evidence that HYG and JNK are about to turn for the better and that could be good news for suddenly moribund U.S. stocks.

“Its been a tough past 12-months for Junk Bond ETF’s JNK & HYG! Performance is nothing to write home about and has lagged the S&P 500 by almost 20%,” says noted technical analyst Chris Kimble of Kimble Charting Solutions. “Over the past few months bullish ‘ascending triangles’ look to be forming. Often time the price action of junk bonds is viewed a key message for what stocks will do going forward.”

Since the start of 2014, HYG and JNK have outperformed SPY, though that is more by virtue of SPY’s decline than overt ebullience in the high-yield bond market. With Tuesday’s gain, SPY is still off about 3% this month while HYG and JNK have posted modest gains.

Diminished expectations regarding defaults could buoy HYG, JNK and rival ETFs going forward.

“The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, decreased 2.1 basis points to 70.5 basis points at 1:56 p.m. in New York, according to prices compiled by Bloomberg. The measure fell by as much as 2.6 basis points today, the biggest plunge since Dec. 18,” reports Jessica Summers for Bloomberg.

In terms of technicals, Kimble says “The key to the patterns above is for rising support to hold and resistance to break. Should support give way, junks performance just becomes junkier! Touch the Junk? If a breakout happens, it would be a positive!”

ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of HYG, JNK and SPY.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.