We’re in the midst of earnings season, and thus far the news is largely positive. Roughly 80% of companies that report earnings beat analysts’ profit estimates, while 69% exceeded sales projections.
However, despite the good news, there has been aggressive selling of risky assets, namely, U.S. equities and high yield bonds, the latter being particularly surprising. All in all, this seems to be a sign of investor fatigue setting in, as I write in my new weekly investment commentary.
Last week, investors pulled $4.2 billion from global exchange traded products, representing the first weekly outflow since late May. Selling was particularly aggressive for U.S. large caps, which lost $6.8 billion, while European equities lost $600 million in their third straight week of outflows.
Still, stock prices are lofty and not a lot of bad news is priced in to the market. Even with decent earnings it appears that investors are getting nervous.
However, high yield is somewhat more surprising. High yield is often thought of as the most “equity-like” segment of the bond market. Good news on the earnings front and a strengthening economy usually translate into support for high yield bonds. In addition, default rates on high yield bonds are low.
Nonetheless, over the past two weeks, $4 billion has come out of high yield mutual funds and exchange traded funds (ETFs). We saw $1 billion leave high yield ETFs last week alone. The recent selling has pushed yields up around 0.40% from their June lows.
True, high yield has seen significant inflows over the past several years, a result of investors’ quest for yield in a low interest rate environment. No one would describe it as cheap.
Still, I’m surprised by the recent outflows for two basic reasons:
The interest rate environment has remained remarkably stable. The yield on the 10-year U.S. Treasury has been hovering around 2.50% as investors have continued to buy bonds amid persistent geopolitical unrest.
Low and stable inflation. Last week provided more evidence that inflation is not an imminent threat. U.S. consumer inflation was in line with expectations, up 2.1% year-over-year, while core inflation actually surprised to the downside with a 0.1% increase. This put the year-over-year number at 1.9%. Despite recent fears over higher prices, for now, core inflation remains well anchored at its 10-year average.
Given the amount of inflows into high yield in recent years, more outflows and volatility are certainly possible in the near term. But for investors with a longer time horizon, I would hold course. I still believe the supply/demand balance is favorable and that high yield continues to offer attractive yields relative to the alternatives.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.