The Trump rally is leaving one popular trade behind

High-yielding bonds are frequently considered to be the stocks of the equity world. After all, their high yield comes at the expense of a greater perceived risk of default, and as the outlook for corporations improve, that risk is seen to drop across the board, giving high-yield bonds a bid.

For that reason, an improving economic landscape, and the promise of greater corporate profitability and stability, is bullish for stocks and high yield bonds alike. This dynamic explains why high-yield “junk bond” indexes and stock indexes tend to move together.

Something a bit different has transpired recently, however. Even as the S&P 500 has risen about 4 percent over the past month in light of an improving economy and amid optimism surrounding Donald Trump’s upcoming presidency, the popular iShares ETF tracking high-yield corporate bonds (HYG) has slipped by 0.5 percent.

It’s no secret what has led to the divergence. Bond prices tumbled following Trump’s win, due to expectations that his policies will lead to increased economic growth and inflation, and that infrastructure spending plans will be funded with increased bond issuance.

While high-yield bonds have many characteristics of equities, at the end of the day they offer a fixed return, and compete with other bonds for the marginal investment dollar. The big move in the bond market, then, has tamped down on high-yield performance, though the group has certainly held up far better than other areas of the bond market.

The collapse in bond prices have led to a substantial change in the relationship between the HYG and S&P 500-tracking SPY. While they had enjoyed a 30-session correlation of 0.88 before the election, indicating that they had been moving in almost perfect lockstep, that number has fallen to 0.54. This is just about the lowest this metric has been since the beginning of the year, and below the average of 0.66 over the past five years.

Amid the shift, some smell opportunity.

“You generally have a positive correlation, but there are periods of time when you get a negative correlation, and when it happens, it actually tends to be a very interesting entry point for the HYG,” Piper Jaffray technical analyst Craig Johnson said Tuesday on CNBC’s “Trading Nation.”

For instance, the correlation between the HYG and the S&P 500 fell meaningfully in the summer of 2010 and in the spring of 2012. In both cases, big one-year rallies for the ETF followed.

Others say the relationship may well have changed meaningfully.

As investors now attempt to predict, and in the future will react to, the policies of Donald Trump, “a lot of these correlations may begin to break down,” Zachary Karabell of Envestnet said Tuesday.

“That said, I think HYG at these levels offers very good yield relative to risk,” Karabell added.

As of Thursday’s close, the ETF offered a dividend yield of nearly 6 percent.

This entry was posted in Markets. Bookmark the permalink.

Leave a Reply