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If recent record outflows from high-yield bond funds prove to be a trend, not just a blip, it could have implications way beyond the bond market, according to a report in the WSJ.
Investors pulled $7.1 billion from the funds in the week through Aug. 6, according to data from Lipper. Well above the next-highest withdrawal of $4.6 billion in the week ended June 5, 2013.
Those two episodes are different in more than magnitude, though. Last June was the peak of the “taper tantrum” that saw bond prices drop and yields rise. By contrast, last week the benchmark 10-year Treasury note touched its 2014 low.
It seems that investors are fleeing from default risk, not interest-rate risk.
Bond manager Pacific Investment Management Co. (PIMCO) notes that junk-bond defaults tend to rise several months after the difference in their yield, or spread, over largely risk-free Treasuries begins rising. Those spreads are correlated with equity returns—particularly the more volatile Russell 2000 Index of smaller companies.
Separating cause and effect can be tricky. BCA Research notes stock buybacks and corporate-bond issuance tend to rise and fall in tandem. Net transfers of cash to shareholders as a share of corporate revenue peaked in late 2007, right around the time bond issuance did. Both hit a trough in September 2009. Recently, both were well above typical levels, though still below their 2007 peak.
If the recent high-yield exodus proves to be more than a knee-jerk reaction to geopolitical concerns, some of the fuel for the equity bull market could be reduced. A useful canary in the coal mine for stocks, something has ruffled its feathers.
Todays Other Top Stories
Municipal Bonds
WSJ: – Kansas settles charges it hid a risk to muni bonds. – Kansas has agreed to settle a fraud case in which the Securities and Exchange Commission charged the state misled investors when it failed to disclose that its underfunded pension system posed a risk to the repayment of some municipal bonds.
Jake Zamansky: – Puerto Rico bondholders see no light at the end of the tunnel. – UBS Puerto Rico Bond fund holders are suffering huge losses. Oppenheimer And Franklin Templeton Funds contain large positions in Puerto Rico debt. These funds are being crushed.
Indexology: – Tobacco settlement bonds: The next cloud on the horizon for municipal bonds? – As the young gas station attendant says at the end of the movie Terminator “there is a storm coming.” While Detroit and Puerto Rico’s financial struggles continue to rattle the municipal bond market, the over $87 billion state issued tobacco settlement bond market is another potential dark cloud worthy of watching.
Bloomberg: – Wall Street settlements bring N.Y. record surplus. – New York state is poised for a record surplus fed by legal settlements with Wall Street banks, creating a buffer against a $1.3 billion Medicaid bill from the U.S. government.
Bloomberg: – California’s Brown reaches $7.2 billion drought bond deal. – Governor Jerry Brown and California Democratic lawmakers reached tentative agreement on a $7.2 billion bond measure for water storage and delivery to drought-stricken cities and farms.
T Rowe Price: – July 2014 – Municipal bonds make a comeback – Podcast. – Jim Murphy, a veteran T. Rowe Price municipal bond portfolio manager, discusses recent developments and the outlook for investing in tax-free municipal bonds.
Bond Market
Market Realist: – Must-know: Why bonds rallied despite weakness overseas. – Last week didn’t have a lot of stuff that could move the bond market, but bonds rallied anyway. Weakness in the Eurozone pushed yields lower, and U.S. Treasuries followed along.
FT Adviser: – Inflation jitters strike bond chiefs. – Strategic bond fund managers have begun to position their portfolios to protect against a rise in US and UK inflation as the two economies return to growth.
ValueWalk: – The shadows of the bond market’s past: 1971-present. – David Merkel looks at the historical environments for the Treasury yield curve and throws in some color from other markets, to see if there might be any lessons for us today. Let’s go!
Treasury Bonds
WSJ: – U.S. Government bonds claw back losses despite higher stocks. – U.S. Treasury bonds clawed back price losses on Monday, shaking off higher global stocks and looming new debt issuance.
Investment Grade
Market Realist: – Why high-grade borrowers are upbeat about market conditions. – U.S. bond markets exhibited different trends for investment-grade and high-yield investors. On the one hand, investment-grade bond mutual funds saw an increase in fund inflows for the eighth consecutive week, while high-yield investors took money off the table in record outflows.
High Yield Bonds
CNBC: – Why Wall Street is going back into junk. – Wall Street is dipping back into the junk bond market after the rout in high-yield corporates resulted in record outflows just a week ago.
Market Minder: – High-yield bond fund flows are junk. – Evidently, the high-yield bond bubble started popping last month. And it’s about to take down equity and bond markets alike. At least, that’s the impression we get from the prevailing coverage of a few weeks of junk bond fund net outflows. It’s all a bit bizarre, in our view. It puts way too much emphasis on fund flows and ignores the fundamentals supporting corporate bonds and stocks. A few freaked out investors doesn’t mean a bond bloodbath—or equity bear market—is nigh.
Yahoo Finance: – Like stocks, junk bonds show investor jitters. – The stock market isn’t the only place that’s been signaling jitters among investors. The $2.3 trillion market for risky U.S. corporate debt has also been under pressure.
Business Insider: – Junk bond funds just experienced a 6-sigma event. – High-yield bond mutual funds saw outflows total an eye-popping $7.1 billion last week. “HY flowmageddon,” said Goldman Sachs’ Charles Himmelberg in a research note. “This is the largest HY outflow on record – a 6-sigma event when flows are scaled by mutual fund assets under management!” Sigma is another way of saying standard deviation. And the greater the number of standard deviations, the more unlikely the event.
Emerging Markets
Investment Week: – EM debt nowhere near bubble territory. – First State Investments’ head of emerging markets debt Helene Williamson argues EM debt valuations have moved away from other fixed income markets, leaving it looking attractive.
Investment Strategy
Market Realist: – The “Great Deleveraging” that never happened: The U.S. debt problem. – For several years, media headlines have been filled with references to a mythical “deleveraging,” or a reduction in the level of U.S. debt. In reality, U.S. non-financial debt has increased, and this has real long-term consequences for the economy. Russ explains.
Bond Funds
David I. Templeton: – Bond funds continue to see inflows. – In spite of what seems like a near uninterrupted advance in the equity markets since the end of of the Great Recession, fund flow data does not suggest investors have reallocated out of bonds into stocks in any significant way.
Bloomberg: – No bonds, no problem as PIMCO increases bets using swaps. – If corporate bonds don’t trade frequently enough for you, one solution is to turn elsewhere. More and more investors are betting on whether the notes will go up or down in value without owning the securities, using derivatives. This has been attractive for asset managers looking to be nimble in markets or make big bets, especially as corporate-debt trading volumes wane.
Gross: There’s no place like home…(click click click)…there’s no place like home…during a tornado or trade war. Stick with Kansas/US.
— PIMCO (@PIMCO) August 12, 2014
Detroit’s exit financing details: up to $300M, structured as financial recovery bonds, 1st lien on income tax rev, 11-15 yr maturity.
— Caitlin Devitt (@Devitt_BB) August 12, 2014
Stocks go down because bonds are down which causes bonds to shoot up which calms down stocks which…
— Ed Bradford (@Fullcarry) August 12, 2014
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