Here’s a Thought for You on High Yield Debt and What I Think It’s Not Telling Us to Do Yet

So, I look at lots of risk signals, and I love watching $JNK. Toward the top of the market, I was warning of caution partly because of how high yield debt was performing relative to equities (e.g., here, here). And that turned out to be prudent as we sort of fell apart. But as we continued to fall, and as we’ve entered this range, I’m not entirely concerned now because of many things I’ve discussed before (e,g, here, here). And that is despite junk bonds continuing to look like total trash here.

So here’s the thinking on this:

  • I have a lot of signals that look ok
  • Junk bonds look completely awful

What am I to do? Am I to assume that junk bonds are telling the truth and that everything else is misleading us? Or am I to conclude that the majority of evidence points to not such a bad risk off environment (no crash, no bear market—at least not yet)? And if the latter, then how do I explain junk bonds?

And so here is how I am going to try to explain that. You see, as a refresher—and to save you a ticker lookup—$JNK does look like total shit here:

JNK

And if you looked at this alone (and many people have shoved this in my face, not knowing that I watch it closely every day anyways), you could reasonably conclude that this is a total risk off environment. I mean, junk bonds are crashing here. And yet, why aren’t other signals lining up with this? And what would we expect the bond market to do in such a “crashy” environment? Wouldn’t we expect capital to flee junk bonds and head to safety—where? Pristine bonds, yes?

Well, we can measure their relative performance, and so let’s do that: $JNK/$TLT looks like this:

JNK-TLT

It’s done nothing but stay in a range all year. That tells us that junk bonds’ death chart is effectively matched by pristine bonds’ performance. And so there’s no flight from poor quality to high quality, but rather, just a general rout in bonds as such. And to me, that does not signal a major liquidity problem, nor a deep concern over the state of things here, but rather, just a basic (but significant) rotation out of bonds altogether as the market adjusts itself by pricing in some rate hikes early. And maybe that’s not so bad.

Here’s what this ratio looks like when times are about to get real tough—examine the COVID crash:

JNK-TLT

Before the S&P 500 had even topped, this ratio had already dumped hard once and was in the process of rolling over hard a second time (there’s your flight to pristine). And that was by the time the S&P had already toppedAnd now? Hell, we topped a long time ago, and this ratio is totally shrugging all of this off. If we’re following that prior course of things, this ratio should perhaps already have dumped once, and perhaps even be well within a second dump now. And it’s not.

And so what I think this is not telling us to do just yet is this: panic.

Of course I am watching things closely, and of course I am concerned about the geopolitical events. But as it stands now, I do not yet think that this is the bear market you are looking for.


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