On 2/9/18, BTS sold high yield bond positions and went to cash, based on indicators weakening. In particular, these related to:
Wage and inflation pressures reflected in the January employment report served as a major catalyst for the correction—which makes sense as we have seen the 10-year Treasury yield break through the 2.6% level and then move over 2.8% in short order.
Bonds relatively resilient but no clear trend yet
In comparison to the recent selloff in stocks, both investment grade and high yield corporate bond markets have been resilient. Yields spreads have widened marginally, and BTS has moved to defensive positioning until the volatility subsides.
This is consistent with our views as expressed in a recent update:
Potential paths forward
Looking forward, a stabilization of indicators could present an opportunity to re-enter high yields and collect “coupon.” Although spreads are at historically tight levels of around 300 basis points over comparable government bonds, a 6% yield to maturity may offer decent return potential.
With the economy growing, a gradual rise in interest rates is normal and may suggest that the risk of a flat yield curve is abating (flat and inverted yield curves indicate risks of recession). A default rate of only 2% among high yield issuers reflects the generally strong cash flow coverage position of corporate borrowers.
However, if the 10-year Treasury breaks over 3% toward 3.25% within a month or so, the stock market is likely to again be pressured. Moreover, a quick move of the 10-year yield over 3% could again pressure high yield bonds. A widening of spreads beyond 300 basis points could lead to momentum selling and present an opportunity to trade in at lower prices.
For now, BTS indicators are keeping assets in money market funds. Volatility increases uncertainty, and a trend needs to be established before investing assets back into the high yield market. Risk remains high that spreads will widen if interest rates move above 3% in the near term.
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.
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