HY moved back to a buy signal early this week. The asset class tends to be a leading indicator of both economic and stock market direction. We had a great run and we are pleased. Right now, the signal is for more “risk on.”
However, much of our return was gained by the sell-off in the second half of last year. Note in the following chart how yields (as compared to Treasury Notes) rose sharply to nearly 9%. Sidestepping the losses in price (when prices sell off, yields rise) and subsequently buying back in at a lower price and higher yield proved profitable.
The biggest concern we have today is that zero interest rate policy (“ZIRP”) has forced investors into riskier assets. HY is one of the recipients of capital flows. The problem is that when money is easy, zombie companies can find financing that enables them to stay afloat.
The risk is that investors will be stung when the next default cycle hits.
We can look at the quality of the debt we might consider by looking at the bond agreement or a bond’s covenants. A covenant is the agreement or legal contract between the borrower and the investor.
Moody’s tracks the quality of covenants in the market and provides an overall covenant quality score (which takes into consideration all of the bonds they rate). Covenant quality tumbled to 4.56 in May from 3.8 in April. Moody’s scores on a 1 to 5 scale with 5 being the worst. May was the largest single-month change on record. Source.
So, keep an eye on HY price activity. I’ve been trading HY for over 25 years. There have been two exceptional opportunities over that time period. One was in 2002 and the other in late 2008. I believe the next opportunity is fast approaching. I believe we will see the greatest default cycle in history, which to me means we are likely to see the single best investment opportunity of my career. Stay tactical!
By Steve Blumenthal | For the rest of the story see Trade Signals: HY Opportunity Ahead (Just Not Quite Yet)
The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change. They do not represent the opinions of CMG. CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts. Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.