The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest high-yield corporate bond exchange traded funds, and rival junk bond ETFs are likely to be heavily scrutinized this year as investors mull the possibility of multiple interest rate hikes from the Federal Reserve.
Due to junk bond’s more “equity-like” nature compared to Treasuries or investment-grade debt, high-yield bonds could strengthen on the higher growth environment in the U.S., especially with rebounding oil prices that would further diminish credit risk for energy-related speculative-grade debt, the largest sector that makes up about 15% of high-yield market.
While interest rates are rising, rates are still hovering near historical lows, which will help make it easier for companies to repay debt or reduce default risks. More quick-witted corporate treasurers have already locked into low, long-term loans, further mitigating default risks.
“Not only are defaults lower, but the earnings of junk-rated companies are higher, it reports, citing research from Bank of America Merrill Lynch. In fact, four out of six investment banks are positive on the sector currently, the Journal finds,” reports Amey Stone for Barron’s.
President-elect Donald Trump may enact looser regulatory restrictions and corporate tax cuts that could allow many companies to repatriate cash and enhance corporate earnings. Bush argued this would mean more cash on balance sheets and less concern over meeting interest payments.
Trump’s protectionist promises could also support domestic companies or support high-yield firms with relatively larger exposure to the U.S. market.
“The high yield sector climbed 17.5% in 2016, its sixth best year in 30 years, notes Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors, in a recent report on S&P Global Market Intelligence’s LCD News. Taking into account financial and economic conditions, he considers it very overvalued.” according to Barron’s.
Alternatively, investors may also consider inverse or short junk bond ETFs to hedge a dip in speculative-grade debt markets. The recently launched Direxion Daily High Yield Bear 2X Shares (NYSEArca: HYDD) tries to reflect the daily performance of -2x or -200% performance of the Barclays U.S. High Yield Very Liquid Index. Additionally, the ProShares Short High Yield ETF (NYSEArca: SJB) takes the inverse -1x or -100% daily performance of the Markit iBoxx $ Liquid High Yield Index.
For more information on the fixed-income market, visit our bond ETFs category.