What's your theory for why U.S. junk bonds (e.g., $HYG) are outperforming U.S. equities (e.g., $SPY)?

A

andyprior

New member
Energy, capital goods, and REITs together make up almost 20% of $HYG's NAV, all of which are being impeded by coronavirus and Saudi v. Russia acrimony, and the rest of it ain't sitting pretty either. Brent crude is down another 5% this morning on Saudi Arabia's promise to pump even more, yet $HYG is about to turn green.

Fed is following Bagehot's dictum, so while investment grade bonds have a buyer, who is putting in bids for $HYG? (Yeah, I'm short).

04/09/20 Edit: Lol nvmd
 
@andyprior I mean as you found out, bonds have a floor that equities don't. It isn't so much that bonds are trading at $50 now because presumably they bought them at $100 but the average recovery value is $50. Equity can and will go to $0 so you don't have that floor. The other thing is the S&P 500 has a decent amount of junk in it, pun intended. IQV, IRM, DVN, APA, M, QRVO.

Perhaps the problem with indexing but if you want to trade this strategy, probably better off doing it versus strong balance sheets but even then, equities on the whole are likely to underperform credit given they are riskier. Where you really see this show up is the IWM (small cap) performance vs SPY or large cap indices.

The other thing is that there is likely some Fed put in HY. They ain't buying HY yet but they'll buy HY before they buy stocks. Look at the index trading at a NAV premium. If things hit the fan, they'll end up supporting the credit while equity likely goes to 0.
 
@chris4god I mean I don't think buying the S&P on the dip is the worst thing. I mean now is when active investing probably makes at least a bit of a comeback. The best thing would be to find stocks you like with solid balance sheets that can weather anything. I don't know enough about active managers who deal with that, I've just been making my own portfolio. I have come across some ETFs in the 'Quality' category which focuses on strong balance sheets so I'd think that might be a bit better. It has outperformed SPY a bit, but not like dramatically.

I think to the OP's original question, HYG is just less volatile than SPY because at the end of the day, equity is a claim on the residual value so any hit to earnings will be multiplied to the equity while bond holders never really priced in that upside.
 
@resjudicata I think that may be a fool's errand, at least for those not on the street and in the know. I mean the Fed said what assets they're buying and only corporate thing that I know of was the IG index. So think people probably think the Fed would next buy HYG instead of individual securities which is probably why HYG trades at a premium to NAV.

I doubt the Fed buys equities. Don't think anyone really knows how the Treasury will structure its loans/investments into distressed companies. But if we get to a true Troubled Asset Relief Program, we're likely talking about buying distressed debt which likely has a long way to fall between now and then.
 
@andyprior Stocks perform based on profitability.

Bonds perform based on solvency.

Guess which one Uncle Sam cares about? It's not the one that gets memed on here all the time.
 
@andyprior The government has made it pretty clear they're providing the necessary credit availability and cash injections to prevent companies from folding. Think about what a bond is: so long as that company remains solvent the bondholders get the yield.
 
@andyprior
  1. Falling interest rates good for bonds, in general
  2. Federal reserve is going to be indirectly buying corporate bonds, driving values up
  3. Bondholders get priority during bankrupcy before equity holders.
 
Best I've found on this thus far is from https://www.gmo.com/globalassets/articles/white-paper/2020/jr_high-yield_3-20.pdf

High yield bonds benefit from a higher position in the capital structure, with senior claims on enterprise value and downside protection in terms of a “recovery floor” on trading levels, which was borne out in 2008. As with the GFC, there are now many bonds trading at attractive yields, below par, and a market implied “loan to value” ratio of less than 50%.

We don’t know where the bottom is, but we know equities took a longer time to recover from the bottom than high yield. Whereas high yield recovered back to 2007 levels fairly quickly, it took until 2012 for S&P total return to claw back from its drawdown. Further, S&P Total Return did not surpass high yield until 2017. We suggest this could be due to a reason that may persist today, which is that fiscal and monetary policy measures have a more direct first order impact on credit markets while the repercussions of economic and wealth disruption may linger and hamper equity recoveries.
Click to expand...
 
@andyprior The best performing asset class over the last 20 years.

My theory is that junk bonds are in a financing “void”. Companies want debt financing because it is tax efficient but banks are not able to provide it to every company due to regulations on risks that banks must comply with.

This leaves companies who want debt financing but are unable to obtain it from traditional sources bidding up the remaining liquidity. It is a little known area in investing that a lot of people don’t want you to know about hence the name “junk”.
 
@andyprior Did you get out? Im still short JNK, cant decide whether or not to hold, I know fed is buying but just read that AMC is filing for bankruptcy and Im sure plenty of others are soon to follow...
 
@adangut I thought about it and ended up concluding there are easier shorts, and now that Fed is putting a floor on it I think that’s even more true.
 
@andyprior Ok just did my research, a few things stood out but the main thing is they're not buying any ETFs at a premium to NAV so basically they are just supporting in case of mispricings, if underlying bonds go to 0 the ETF will still take the hit regardless of Fed backing. They're also capped at 20% of shares outstanding so not a huge amount on JNK (8.5B AUM so 1.6B cap on 1.1B daily trading volume, HYG has 15B AUM and 3.5B daily vol FYI). I think I will hold onto this one, lets see what happens I have until June.
 
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