A Few Observations on Junk Bonds

I want to make a few observations on $JNK. I like to watch it (and other high-yield debt instruments) for signals. Now, when we simply look at the chart, it’s in a total free fall, a total bloodbath:

JNK

It gives us the appearance of a total risk-off environment. That said, there is a part of me that wonders if this is really true.

To begin with, note the excellent bullish divergence that is forming on the daily RSI. That is more indicative of a move ending, rather than just getting started. Now, that divergence can break, and a deep plunge in the ETF from this point will be an excellent signal to us. But it hasn’t yet, and as it stands, this may bottom at any moment.

The second thing I want to discuss is the possibly misleading nature of looking at $JNK in isolation, especially in this environment. After all, it’s not just junk bonds that are crashing, but pristine bonds backed by the most powerful sovereign state in human history are crashing, too; a total bond market rout as such, as the bond market as a whole prices in rate hikes.

I’ve looked at this before (I recommend reading that article if you haven’t yet), but one way I think we can eliminate some noise is by using a ratio, in this case JNK/TLT. What it should tell us is some information about the relative performance of these two classes of bonds, high and low risk.

And what I would like to think is that in a genuine risk-off environment, capital would flee trash and seek safety, moving from junk to treasuries. And what that should look like is this ratio falling.

And, as you can see leading into the COVID crash (for instance), the ratio was rangebound, but then fell from that range. And now? We were rangebound, but we’ve rallied from our range. And so at least so far, junk bonds are outperforming pristine bonds on a relative basis, despite the total crash in junk bonds, meaning: capital is fleeing treasuries more than it is fleeing junk bonds. Weird, yeah? This chart seems to be saying that, on a relative basis, junk is being “fled from less” than treasuries.

JNK-TLT

This could change, but for the time being, it doesn’t seem to signal the same kind of risk-off environment I would expect to see before a liquidity crisis.


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