High yield bond markets have been selling off aggressively this year. Goldman Sachs says that means “2015 could become the worst non-recession year for HY”.
A large part of this weakness, Goldman says, is because lower oil prices is hurting investors’ “risk appetite”.
But in an interview with Marketwatch, George Putnam, long term junk bond watcher and editor of a newsletter service which has beaten the stock market by 7.3% per annum for the past 15 years, says it’s the structure of the market which is also contributing to the junk bond selling.
Putnam said there has been a change in who invests in junk bonds. In the past, these types of investments were the purview of institutional investors and mutual funds. These players took the long view, Putnam said, and often had contrarian instincts to step up and buy bonds as their prices fell or the market was in distress.
But that’s changed because of exchange traded funds and the instant liquidity they seek to provide.
Putnam said ETFs “have become the investment vehicle of choice for short-term investors, such as hedge funds”, which tend to be “trend followers and, therefore, are just the opposite of being contrarian: They buy on strength and sell on weakness.”
So these investors are selling now, when in the past the market might be experiencing some bargain hunting.
The second major factor Putnam identified is related to the regulatory own goal that global bank regulators have scored in making markets less liquid than the past in an effort to make banks safer.
New regulations demanding more capital against trading positions make it more difficult for banks to enter the market to buy and warehouse bonds that they believe represent value to then on-sell at some future point in time when market ructions have passed.
“Big investment banks that otherwise might be buying junk bonds right now are on the sidelines,” Putnam said. That means two types of buyers who would usually enter the market to smooth the volatility are absent.
So the selling continues.
But don’t believe the doomsayers who say this junk bond sell off is the precursor of a recession. Putnam says that now is one of the many times such a sell off has not signalled recession.
Rather, he believes the US economy will just continue to muddle through.
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