As speculative-grade debt and related junk bond exchange traded funds continue to weaken, some worry that the risk-off mentality will seep into the equities market.
The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) has fallen 1.7% over the past month while the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) has decreased 2.0%.
“Equities are unlikely to rally in the midst of substantial a high-yield selloff,” one hedge-fund manager who focuses on the credit markets said on CNBC. “There will be a correction at some point,” he added, “whether it just started, or in the next six months.”
More hedge funders are concerned that some businesses are experiencing bubble-like valuations after the easy-money policies helped fuel market gains.
“Financial asset prices are artificial, the equilibrium is temporary, the lack of volatility is a trap, and when the whole thing bursts, there will truly be hell to pay,” Elliott Management said. “Investors are ‘seeking yield’ now in assets of lower and lower quality, with more and more leverage, and with less and less yield to compensate for risk.”
As investors begin to worry about market volatility, high-yield bonds and riskier assets begin to feel the heat. Consequently, a number of hedge funds, like Ellington Management, Tilden Park Capital and Libremax Capital, are shorting junk bonds.
In the ETF space, the ProShares Short High Yield ETF (NYSEArca: SJB), an inverse play on the Markit iBoxx $ Liquid High Yield Index, has gained 1.9% over the past month. [Unheralded Bearish Junk Bond ETF Grows by 50%]
Meanwhile, the S&P 500 has dipped 2.2% and the Dow Jones Industrial Average fell 2.8% over the past month. Investors, though, can look at inverse plays to hedge broad markets, such as the ProShares Short S&P500 (NYSEArca: SH), which tries to reflect the -100% daily performance of the S&P 500, and ProShares Short Dow30 ETF (NYSEArca: DOG), which tries to reflect the -100% daily performance of the Dow Jones Industrial Average. Over the past month, SH is up 2.1% and DOG gained 2.7%.
For more information on speculative-grade debt, visit our junk bonds category.
Max Chen contributed to this article. Tom Lydon’s clients own shares of HYG and JNK.