XTF Sector Research High Yield Debt

Transcription

1 High Yield Debt ETF Sector Report and Analysis XTF Research 110 Wall Street 18th Floor New York, New York Telephone (646) Igor Zilberman, CFA John Hughes, Managing Director Scott Maragioglio, Director of Research Table of Contents: Monday, November 02, 2009 Sector Report Commentary 2 Index Charts 3 Spreads & CDS Indexes 4-5 Fundamental Data 6-7 XTF Power Ratings 10 1

2 Relative Strength Comparative(S&P 500 INDEX) High yield debt is lagging, but generally keeping pace with the S&P SPDR BARCLAYS HIGH YIELD BOND ETF High yield corporate debt has surged along with the equities markets. Traders are viewing corporate and high yield bonds as a better risk-reward scenario at the moment Weakening with the equity market Double Bottom 25 Volume 3000 x1000 May Jun Jul Aug Sep Oct Nov Dec 2009 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Barclay s High Yield Bond ETF (JNK) Monday, November 02, 2009 Chasing Yield The corporate and high yield markets have soared this year as traders chase yields. Scott Maragioglio (813) smaragio@epiphanyresearch.com Corporate and high yield debt have been the trade since the beginning of the year. The spreads between corporate, high yield and government debt widened dramatically during the financial crisis. Once traders sensed the worst had passed and liquidity started to flow out of the safe haven of government debt and back out into the capital markets, the corporate and high yield bond markets appear extremely attractive to yield seeking investors. The question now is whether or not the amazing run in these markets will continue? We believe there is enough momentum in these markets to carry them higher in the short-term, but the best part of the rally in government and high yield debt is likely over. Technically the investment grade, high yield and emerging market bonds are still very much on the offensive. The high yield index has formed a bullish reversal and trended higher in a similar trajectory as the equities market. The rally in high yield and emerging market debt in particular highlight the return of speculation on the part of traders. Many investors see a better risk-reward scenario in the high yield debt market versus equities. Up to this point they have been correct in this assumption. High yield bonds have kept pace on a principal return basis with the equities market while paying out excessively high yields. This has been a great trade on the long side. Corporate bonds have also surged higher and may continue to carry through to the upside, but we see potential problems with the bubble type price action this group has produced recently. Investment grade debt may need to consolidate the gains before another leg to the upside is possible. Spreads between investment grade and high yield debt have contracted significantly, but they are still above normal levels. The gap in the spread should continue to contract, which may provide more upside to high yield debt, but once the gap is closed the catalyst for further upside should be gone. The aggressive Fed policy on rates this year means the only avenue left for rates is to the upside. Once corporate and high yield debt adjusts for the new rate and economic realities there will be little room for the bulls to maneuver. The short-term technical picture for the high yield debt market remains bullish, but we believe now is the time to start increasing caution and viewing these markets through a skeptical eye. Caution flags always go up early in an extremely bullish rally such as this. Momentum is a powerful force and can carry these bonds higher, but we are starting to see cracks in the bullish thesis and real problems if the excessively loose monetary policy leads to any measure of inflationary pressure. 2

3 Bonds Corporate and Emerging Market Debt High grade corporate bonds are seeing a parabolic move to the upside. The group has recovered from a breakdown and actually broken out of the trend channel to the upside. This looks like a bubble, but it could extend farther. Long-Term Uptrend Channel Dow Jones Corpor Matching Channel Overthrows "Bubble"? Uptrend Relative Strength Comparative(Dow Jones CORP BD PRICE) Corporate vs. Emerging Market Debt JPM BOND INDICES Emerging market debt has out performed corporate bonds on a relative basis since the beginning of the year. Traders are reaching out on a limb for higher yields September December 2009 February March April May June July August September October Nove 3

4 Bonds AAA-BAA Spread IGHYSPREAD Inverstment Grade AAA vs. High Yield BAA Corporate Debt Spread. Spreads still have room to move to get back in line with historic levels. This may encourage the bulls to continue buying. Normal Range Peak in default concerns Still room to move DBAA 9.5 Back to 2006 levels, but the fed has moved rates lower DAAA AAA Bond Yields Back into the recent range

5 Bonds Investment Grade & High Yields Credit Default Swap Indexes Credit default swap prices have moved steadily lower since the peak of the crisis. Traders are clearly more optimistic about the outlook for the economy and corporate default rates than they were earlier in the year. 5

6 Treasury Yields Weekly Charts CBOE 30 Yr Treas 20 Secular Bull Market in Long-Term Bonds Test Retest Bond prices have moved higher over the last 20 years within a well defined trend channel. The recent pullback in bond prices tested the lower end of the channel, but support held and we are now seeing a rebound. A break of this channel would correspond with a 4.9% yield. A breakdown would signal a change in the secular bond bull Long-term trends in government debt show that the secular bull market for government bonds is intact. The trend channel for the 10 & 30-year bonds is holding for now, despite well stated inflation fears on the part of traders. A break below 4.9% would be a real bearish change in the long-term secular bull market for long-term debt. The 10- yr bond is in the middle of the range and would need a move below 4.5% to break the secular trend. CBOE 10 Yr Treas 15 Test of Resistance 20 Secular Bull Market 10-yr Bonds Long-Term Uptrend Channel Test of Support 4.5% The 10-yr bond is in the middle of the secular trend range. We would have to see rates rise to 4.5% here to produce a real bearish change

7 Fundamentals Interest Rates 10-Year Bond Summary This report analyzes the average annual level of nominal interest rates on 10-year constant maturity Treasury securities as measured by the Federal Reserve. This measure is normally quite highly correlated with average interest rates on standard 30- year mortgages. Latest Data According to the Federal Reserve, the average daily level of the market yield on 10-year constant maturity treasury bonds over 2007 was 4.63%, a decrease from the previous year's average of 4.8%. Falling yields were witnessed over the second half of the year, as credit market problems related to the subprime mortgage crisis began to affect the performance of the stock market. This was particularly evident in the late July/early August period, coinciding with subprime problems reported by Bear Sterns and the bankruptcy filing of American Home Mortgage, precipitating the current stock market troubles. Therefore, as the stock market run into trouble, and with the residential investment market still slumping, investors turned to treasury securities, seen as being almost risk-free, and the higher demand pushed down the yields. Though this effect was more pronounced in the case of short-tern debt instruments, the cause-and-effect relationship for longer-term securities is still apparent. For 2008 as a whole, yields on 10-year bonds averaged 3.66%. Rates remained low over the first quarter of 2009, averaging 2.74%. Five-Year Trend During the period following the burst of the tech bubble (and the recession that lasted from March until November 2001), demand for treasury securities increased as stock markets went into decline, as is shown in the table below: Stock Market Performance vs Average Bond Yields Percentage Percentage Percentage Year Dow Jones Change NASDAQ Change Average Bond Yield Economic recovery that began fully in 2004, with real GDP growth of 3.6%, helped to ease demand for bonds, with yields climbing on an annual basis from 2004 until 2006, before a decline was seen in 2007 for reasons explained above. Demand and Supply Factors 10-year bonds are a means by which the government borrows money from the public in order to cover debts. The yields are issued at auctions by the Bureau of the Public Debt, which determine the yield paid at regular intervals. The bonds can then be traded privately amongst individuals before being redeemed for the face value upon reaching maturity. Government bonds are considered to be almost risk-free investments, as the government is capable of raising taxes or printing more money in order to redeem the face value of the bond upon maturity, and therefore should not default. It should be noted that if the government were to use inflation in order to obtain the money to pay securities holders, this could very well mean that, in purchasing power terms, the bond actually lost money for the investor. Long term rates are set by the market, as a result of supply and demand forces. Lower long term rates indicate investors are predicting a slowing economy. A strong economy would encourage investors to invest in other parts of the economy as they would gain a higher return. A weak economy encourages investment in bonds as they are considered a safer option. 7

8 Long-term interest rates are generally correlated with one another, reflecting expectations of future economic conditions such as inflation and growth. Yields on 10-year bonds are particularly highly correlated with interest rates on 30-year standard mortgages, to the point where movements in the former can be used as a proxy for predicting the latter. Outlook With the weak economic conditions that are expected to prevail this year, it appears certain that demand for bonds will remain strong, particularly after the most recent market turmoil that has included the government having to take control of Freddie Mac and Fannie Mae, the collapse of Lehman Bros and the bailout of insurance giant AIG. Now that Treasury has been authorized to create a new body to purchase bad assets from financial companies, this may result in an increase investor confidence, but it is likely that yields would remain relatively low nevertheless. IBISWorld predicts that the average yield on 10-year bonds will fall by a further 86 basis points over 2009 to reach 2.8%. As the economy enters a period of more normal growth subsequent to this, bond yields are seen as normalizing over the remainder of the outlook period. The extra debt taken on by the US government to fund its efforts at economic stimulus, unsettling foreign holders of US debt such as China and Japan, will necessarily result in a rise in interest rates in order to attract investors. Graph: Interest Rates - 10-Year Bond Rate Year Percentage Abs. Change

9 200-day comparative relative strength INTERNET SPECIALTYRETAIL BANKINGMONEYCENTER COMPUTERHARDWARE GAMING AUTOMOTIVE RESTAURANTS METALS CONSUMERNONDURABLE LEISURE FOREIGNFUNDS SP_ENERGY FINANCIALSERVICES CONSUMERDISCRETION SP_CONSMR_DISCRETION ENERGY SP_TECHNOLOGY TECHNOLOGY ELECTRONICS SOFTWARE Nasdaq100 ENERGYEXPLORE CONSUMERDURABLES WHOLESALE S_P100 SP_INDU_MATERIAL INDUSTMATERIALS MEDIA TELECOM_EQUIP FOOD FOREIGNREGIONAL S_P400 CONGLOMERATES CHEMICAL TELECOM Russell1000 SP_REIT CLOSEDENDDEBT MEDICALEQUIP DJIA CLOSEDENDEQUITY S_P500 Russell3000 SP_TELECOM MANUFACTURING AMEX S_P600 WIRELESS_COMM REALESTATE Russell2000 NASDAQ DIVERSIFIESSERVICES MEDICALPRODUCTS MATERIALS SP_CONSMR_STABLES CONSUMERSTABLE SP_INDUS_CYCLIC INDUSTCYCLIC RETAIL HEALTHSERVICES TOTAL_MRKT TRANSPORTATION NYSE SP_FINANCIAL INSURANCE AEROSPACE SP_HEALTH UTILITIES SP_UTILITIES BANKING SAVINGSANDLOAN DRUGS BANKINGREGIONAL TOBACCO BIOTECH 9

10 ETF Description Structural Integrity Rating LQD ishares iboxx $ Investment Grade Corporate Bond 7.0 ETF Symbol Expense Ratio 0.15% Barclays Global Issuer Index # of Securities 1YR Returns iboxx $ Liquid Investment Grade Index Exchange % New York Stock HYG ishares iboxx $ High Yield Corporate Bond % Barclays Global iboxx $ Liquid High Yield Index % New York Stock GBF ishares Lehman Government/Credit Bond % Barclays Global Barclays Capital US Government/Credit Index % New York Stock GVI ishares Lehman Intermediate Government/Credit Bond % Barclays Global Barclays Capital Intermediate US Government/Credit Index % New York Stock CFT ishares Lehman Credit Bond % Barclays Global Barclays Capital US Credit Index % New York Stock CIU ishares Lehman Intermediate Credit Bond % Barclays Global Barclays Capital Intermediate US Credit Index % New York Stock CSJ ishares Lehman 1-3 Year Credit Bond % Barclays Global Barclays Capital 1-3 Year US Credit Index % New York Stock PLK PowerShares Active Low Duration Fund 2.8 JNK SPDR Barclays High Yield Bond ETF % Invesco Power- Shares Capital Management LLC 0.40% SSGA Funds Management, Inc Custom % New York Stock Barclays US High Yield Very Liquid Bond Index % New York Stock 10

11 Marco Polo XTF 110 Wall street New York - NY