In the 1970s the popular kids television show,
, had a segment called "Three of These Things Belong
Together". The segment was based around a song with catchy
lyrics saying, "Three of these things are kind of the same.
Can you guess which one of these doesn't belong here?"
The point of the segment was to help children develop their
cognitive skills through observation, classification, and problem
That segment has since been phased out of Sesame Street's
programming, but the value of the underlying skills developed is
one that should last a lifetime.
Three of These Things - The Grown Up Version
Sometimes the skills learned as a child are indeed the ones most
useful to us as adults. This is as true when it comes to the
walking, talking, and eating abilities we learned as children as it
is with the cognitive skills we also sharpened.
As a market strategist one of my jobs is to continually peruse
the various markets in search of asset classes that offer
opportunity. This often includes finding and assets that are
not behaving "normal".
Interview with Chad Karnes on the Index Investing
The chart below compares the iShares Treasury Bond 7-10 Year
(NYSEARCA:IEF), the Market Vectors High-Yield Muni (NYSEARCA:HYD),
the iShares S&P National AMT-free Muni Bond (NYSEARCA:MUB), and
the SPDR Barclays High Yield Bond (NYSEARCA:JNK) performance year
to date, presenting a similar setup as the outlier game we played
as a child.
Three of these bonds belong together, and one of them indeed is
not like the rest.
The chart above shows that when comparing the Treasury
(NYSEARCA:TLT), Municipal, and Corporate bond categories, junk
corporate debt is the only bond category that has gained in value
this year. Junk bonds are the outlier, not participating in
the bond sell off thus far, and that raises some suspicion.
Rising bond yields are something we have been able to get ahead
In May, we were warning that a rising rate environment was
around the corner, and our Technical Forecast readers were provided
the analysis, charts, and trade alerts to take advantage of the
trend change when we suggested:
"Continue to switch into shorter durations" and "shorter term
bonds such as the iShares 1-3 year Treasury bond (NYSEARCA:SHY)
or the Barclays 1-3 month T-bill (NYSEARCA:BIL) remain the safer
place for your bond money".
That move saved Treasury owners over 9% as the longer durations
saw large downside moves.
The rest of the bond market may be setting up something similar
as corporate debt (NYSEARCA:LQD) won't be able to indefinitely
evade the damage of rising yields.
What are the Implications?
Junk bonds have been the positive outlier this year when it
comes to the bond market's performance, rising 5% YTD, and this
raises red flags. Why hasn't it joined other bond sectors
like Treasuries and Municipals in a price decline?
Are corporations with lower creditworthiness immune to
rising interest rates?
As discussed in our November
Profit Strategy Newsletter
published 10/18, corporate bonds are now also underperforming
compared to their historical relationship with the equity markets,
and this could finally spell trouble for the high yield bond
market. Stocks have made new highs, yet junk bonds have only
managed a double top.
Combining this underperfomance with the analysis outlined by our
game above, we see this as a warning sign that corporate bonds will
likely be the next bond shoe to drop, joining the other three debt
classes in lower price, where it likely belongs.
Given that junk is the riskiest of corporate bonds, the
adjustment back in line with its peers suggests a potentially swift
10% downside move as yield increases also hit the corporate bond
The ETF Profit Strategy Newsletter keeps you ahead of the
market's trends. Junk bonds have held their ground as the
broader bond market sells off, but this outperformance is not
expected to last as corporate bonds are starting to show some
cracks in their uptrend.
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