High-yield corporate bond exchange traded funds, such as the iShares iBoxx $ High Yield Corp Bond ETF (NYSEArca: HYG) and the SPDR Bloomberg Barclays High Yield Bond ETF (NYSEArca: JNK), struggled last year. However, early in 2019, those funds are rebounding and data suggest investors are embracing the rally.
Some market observers believe the junk bond rally could be short-lived and that the asset class could disappoint again this year.
“According to Bloomberg, high yield bonds limped into 2019 after suffering from a December selloff that was the worst month for the asset class since 2011,” said State Street in a recent note. “Most high yield experts chalked up the volatility to a liquidity driven event rather than a negative assessment of the asset class’ fundamentals. An index of high yield bonds declined about 2.6% in 2018.”
Although junk bonds struggled last year, many analysts were bullish on the asset class heading into 2019.
“Despite the losses, strategists have been ratcheting up their forecasts for high yield bonds in 2019. Perhaps they are emboldened because high yield bonds have only suffered an annual loss seven times in the last 35 years and they have never had negative returns in consecutive years. In fact, on average high yield bonds have surged 29% in the calendar year following a negative performance year,” according to State Street.
What’s Next
JNK seeks to provide investment results that correspond generally to the price and yield performance of the Bloomberg Barclays High Yield Very Liquid Index, which is designed to measure the performance of publicly issued U.S. dollar denominated high yield corporate bonds with above-average liquidity. HYG tracks the investment results of the Markit iBoxx® USD Liquid High Yield Index, which is comprised of high yield U.S. corporate bonds that have less than investment-grade quality.
State Street acknowledges there are some factors that are supportive of junk bonds this year.
“A number of additional factors support the positive outlook for high yield bonds,” said the firm. “The US economy is likely to grow 2.5% this year, corporate profits are rising albeit at a slower pace, the Fed is taking a pause from interest rate hikes, inflation expectations are modest, high yield supply is shrinking and default rates remain low relative to their long-term history. What’s not to like?”
Still, there are other issues junk bonds need to contend with, including slowing economic growth.
“Both US economic growth and earnings are decelerating. High yield spreads relative to Treasuries widened last year but remain well below long-term historical averages,” said State Street. “This means the compensation investors receive for taking credit risk is still way below historical norms. And although supply is shrinking, high yield bond issuance has exploded in the post-global financial crisis environment of low rates. As a result, even marginally tighter monetary policy, slowing growth and earnings may have outsized negative impacts on default rates and spreads.”
For more trends in fixed income, visit the Fixed Income Channel.