Diary of a Financier

Intraday Update: High Yield Highs to Come & Go… Then Come Again

In Capital Markets on Fri 24 Aug 2012 at 13:45

I noted a dichotomous divide in the High Yield ETF (HYG) earlier today. I wanted to expound on those observations, and put the words into pictures with some charts.

HYG is trading ~$91.90 intraday. From here, High Yield Credit will brush resistance at its 52-week highs ~$92.26 (green) at the behest of a breakout from an ascending triangle (blue). A shorter-term rising wedge (yellow) exists too, but it’s engulfed by the longer-term triangle, and therefore it loosely governs this pricetrend:

HYG daily- shorter-term rising wedge (yellow) overruled by ascending triangle resistance at $92.

Ultimately, bear divergence on the daily chart endangers a more material, more sustainable breakout. Thus, I expect a pullback eventually. Such bear divergence in indicators has failed to materialize in HYG’s price only once in four occurences post-crisis. That one failure resulted in a blowoff top–propelled by euphoric buying–that ultimately collapsed in January 2010:

HYG daily- in the post-crisis era, bear divergences only failed to end in a correction once (in 2009-10, HYG rallied into a blowoff top, aided by euphoric buying)

Fundamentally, everyone keeps citing wide High Yield bond spreads as a bullish bullet. Where are the quants and the mathematicians on this one? As the 10y yield (TNX) nears a zero bound, every basis point +/- is a bigger percentage move. For example, a 5bp drop in TNX from 2.00 to 1.95 is a 2.5% decline; a corresponding 10bp drop in HY rates from 7.00 to 6.90 is only a -1.43% move. This is the reality of convexity. Absolute spreads are the wrong metric to apply here. Instead, we should be citing relative spreads, which are actually at modern lows:

HY Absolute & Relative Spreads- while absolute spreads are somewhat attractive, relative spreads are at modern lows.

So, I can envision better relative value for new positions. In the end, I don’t expect anything like a collapse in the High Yield space, just a pullback. Nontraditional monetary policy tools have engendered a risk-takers’ environment, justifying both historically tight absolute and relative spreads in High Yield. Using the same post-crisis occurences of bear divergence in HYG, I turn to the weekly chart, where I notice that there’s no bear divergence in the intermediate term–in contrast to those prior corrections:

HYG weekly- currently no divergence, as opposed to previous corrections wherein bear divergence had developed.

This rise & fall will offer the buying opportunity I’ve hoped for–a chance to drop my last muni/Treasury remnants and cycle into High Yield. I already own four singlename, junk-rated bond issues. I own a fair amount of floating rate paper (also junk). The next slug will be an HYG allocation, which I can trade a little more tactically with tighter spreads.

–Romeo

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  1. […] are incredibly thin, but I’ve maintained our fixed income allocations [almost entirely] in High Yield ($HYG) and Senior Floating Rate Bank […]

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