All Eyes on High Yield

This weekend’s Barron’s cover story was about what could go wrong in the markets thanks to the massively important ETF complex, which, as Rick Ferri points out in the story, has tripled in size since the Credit Crisis era. There are some really good points in the story, especially the stuff about how there are lots of ETFs that are highly specific or niche-y, and their underlying securities may not be able to bear a mass liquidation that catches the authorized participant traders by surprise.

Another area of concern – very much related – is the high yield bond sector. There’s been quite a bit of jitters of late thanks to huge, sudden outflows from the funds that play there. This week there will be more people watching junk than during the series finale of Sanford & Son back in ’77.

Here’s FactSet with a quick primer on what’s been going on in junk bonds:

One of the big topics of interest this year has revolved around a combination of correction expectations and bubble concerns. The bubble concerns seem much narrower, but tend to be viewed as potential tipping points for a broader market selloff. Such thinking was prevalent this week as junk bonds, a pocket of the market in which the Fed has highlighted stretched valuations, remained under scrutiny. A WSJ article noted that some of most successful fund managers during the financial crisis are starting to turn bearish. It highlighted junk bonds as a particular area of focus. Mutual funds and ETFs focused on high-yield debt saw net outflows of $1.5B this week. This followed redemptions of ~$2.5B in the prior week and ~$1.9B in the week before that. In addition, according to Lipper, investors pulled more than $5B from these funds in July, the most for any month since the record monthly outflow of $15.6B in June 2013, when the taper tantrum was in full swing. High-yield spreads also pushed out to six-month wides, while the iShares high-yield ETF, HYG (2.1%), fell for its sixth straight session on Friday and suffered its biggest weekly pullback in just over a year.

Mark my words, it’s all eyes on high yield starting tomorrow – everyone’s using it as a proxy for risk appetite now given the threat of higher rates sooner that has gripped the market.