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Junk Bonds: This Correction Isn't Over Yet

With global markets' concern shifting from the Fed to China's central bank yesterday, the People's Bank of China responded today with some reassuring noises, according to which "liquidity risk in the banking system is under control" and, better yet, "we will stabilise market expectations and guide market interest rates to reasonable levels."

That appears to have been enough to calm world markets, including the U.S., where the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) are up % and %, respectively, at 10:10 a.m. EDT. However, China's overnight repurchase rate remains elevated at 5.8% -- not far below the overnight dollar London Interbank Offered Rate's all-time high of 6.875%, achieved at the height of the credit crisis in September 2008. For more on this situation that bears watching, I recommend "China's Ponzi Credit Boom Faces Crunch" (requires subscription) from UBS' excellent George Magnus.

Getting rid of junk
Virtually all asset classes took last week's Fed announcement on the chin -- risk assets and so-called "safe havens" alike. Junk bonds certainly didn't escape the carnage; in fact, the two most popular junk bond ETFs, the SPDR Barclays High Yield Bond ETF (NYSEMKT: JNK  ) and the iShares iBoxx $High Yield Corporate Bond Fund (NYSEMKT: HYG  ) , performed almost as badly as the S&P 500 through yesterday.

Regular readers of this column know I've been warning investors that the junk-bond market looked dangerously overheated. The correction we're now witnessing suggests that was indeed the case. The yield on the Bank of America Merrill Lynch US High Yield Master II Index jumped from 6.27% last Tuesday to 6.99% yesterday. However, the Fed's announcement seems only to have accelerated a process that began in May, as the one-year graph of the yield shows:

The yield has leapt from a low of 5.24% on May 8 to just less than 7% in less than two months. That's substantially more than the increase in the 10-year Treasury yield over the same period.

For the week ended June 19, Lipper's latest mutual-fund flows data shows investors pulled $333 million out of high-yield bond funds for a fourth consecutive week of net outflows. You can expect the week ending tomorrow to make that five; this correction has some room yet to run.

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  • Report this Comment On June 25, 2013, at 6:17 PM, EricTheRon13 wrote:

    You provide zero reasoning for your assertion. I too think that the overall correction isn't over yet, but not just for high-yield. You can bet when corporate bonds go down, stocks will follow, especially when it's a sharp uptick in rates. This will be over at some point after stocks have taken about two times the drubbing that high-yield has, since that's been the historical norm.

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