October 1, 2018 | by Matthew Pasts, CMT, CEO, BTS Asset Management, Inc.

Stock Market’s Record Highs with Low Volatility – Implications for High Yield

Historically, high yield bonds have correlated closely with the stock market. The S&P 500 has now moved above its January 26, 2018 high. Price strength over this key level has strengthened the positive trend in the high yield bond market.

We remain invested in high yield in our tactical investment strategy but recognize areas of concern in the stock market, some of which are subtle. One example is the low level of expected future volatility (“implied volatility”) of equities, as measured by the VIX index.

One implication of a low VIX reading is that risk managers and speculators are required to take on greater equity exposure through the options market in order to collect the same level of premiums as compared to an environment of high or normal implied volatility. This dynamic may introduce a source of hidden instability to the markets, because a low VIX can actually amplify stock market declines if a “risk off” scenario emerges.

For more on this idea, read “It’s Never Different This Time” by Harley Bassman, January 29, 2018: http://www.convexitymaven.com/images/Convexity_Maven_-_It_s_Never_Different_This_Time.pdf

The bottom line is that while a higher-trending stock market is generally supportive of high yield, it’s important to be ready to act quickly when market dynamics change.

---

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.