June 18, 2018 | by Matthew Pasts, CMT, CEO, BTS Asset Management, Inc.

Medium-Term Trend for High Yield Remains Positive

The high yield bond market experienced some weakness subsequent to our most recent “buy” allocation on April 12, when BTS indicators changed from negative to positive status—pointing toward a positive medium-term trend.

We remained invested in high yield bonds during this weakness because our model remained positive—which appears now to have served us well. A goal of the model is to keep assets invested during short-term weakness when the intermediate-term trend is intact.

A relatively stable high yield market offers the opportunity for investors to benefit from coupon payments on bond holdings. In our experience, it often doesn’t pay to be defensive during a sideways trading range.

Continued Correlation to Stocks

High yield bonds have correlated with stocks since the January high and during the formation of the second low in early April. Stocks remain about 3% off their January highs and are up around 8% since the April lows. We think that stocks’ movement back up to their 2018 highs has helped the high yield sector find solid support.

10-Year Note Remains a Key Risk Factor

All fixed income could come under pressure if the yield on the 10-year note remains over 3% and continues higher to 3.50%. The 3-month range of TNX (10-year yield) has moved higher, to 2.75-3.11% from 2.62-2.94% about a month ago. The current level is about 2.91%. The very recent move to the lower end of the range has helped take downside pressure off of fixed income for now.

With the bond market stable after last week’s rate hike by the U.S. Federal Reserve and the European Central Bank’s dovish statement, we think high yields and the stock market have the potential to move higher.

That said, defensive positioning is always an option. BTS’ strategy is to focus on preservation of capital, trying to sell during any sustained downside move in prices and then buy low after credit spreads have widened. During sell-offs in risk assets, we seek potential gains in government bonds in “flight to quality” trades.

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It should not be assumed that investment decisions made in the future will be profitable or guard against losses, as no particular strategy can guarantee future results or entirely protect against loss of principal. There is no guarantee that the strategies discussed will succeed in all market conditions or are appropriate for every investor.