Yesterday we looked at the behavior of emerging market bond funds as a means of gaining insight into the mood of the market. Closely related to the behavior of emerging market bond funds is the behavior of high yield corporate bonds (also known as junk bonds). The reasoning is simple…….if you get even a slight hint of problems on the horizon you don’t want to be in junk grade bonds because of their illiquidity and sensitivity to economic contraction (which implies cash flow contractions and corporate defaults).
Yes we do see weakness in junk grade bonds…..but it has only been over the last two days and even then it has not been significant. Usually weakness in equity markets is preceded by weakness in emerging market bonds and junk grade bonds…….could this time around be different? Could equity markets be leading junk grade and emerging market bonds? If it did it would be a first! The mere fact that junk grade bonds are not showing any weakness of significance suggests to us that the weakness in equity markets is nothing but the markets’ attempt to kick weak hands out of the market.
The four charts below depict the performance of four of the largest junk bond mutual funds in the US.
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