The Seasonal Trade You're Not Thinking Of But Should Be
The iShares iBoxx $ High Yid Corp Bond (ETF) (NYSE: HYG) and the SPDR Barclays Capital High Yield Bnd ETF (NYSE: JNK), the two largest high-yield corporate bond exchange-traded funds by assets, are down an average of 4 percent, but those declines only tell part of the story.
Amid a spate of energy issuer defaults and downbeat performances by CCC-rated issues, tensions are running high in the U.S. junk bond market.
Recent Volume Increases In HYG And JNK
Those tensions have translated into enormous volume increases for HYG and JNK, leading to days in which both ETFs were found among the most traded securities on U.S. exchanges.
As highlighted by outflows from HYG and JNK and inflows to the ProShares Short High Yield ETF (ProShares Trust) (NYSE: SJB)), some bearish traders have recently had their ways with junk bond ETFs; however, a case can be made that short high-yield is becoming a crowded trade. And if the trade gets too crowded, a rip-your-face-off rally could ensue. As it is, the calendar sets up nicely for junk bonds to rally in January.
In a note out Tuesday, Rareview Macro founder Neil Azous, citing JPMorgan data, pointed out that January is often kind to junk bonds.
“If you are looking for where the beta is on a relief in high yield or unwind of hedges following the FOMC meeting (on a very dovish outcome) small caps are likely to win out. Additionally, for reasons we have seen in December so far it is no wonder why the best month of performance for high yield is historically in January,” said Azous.
Historical Performance Of High-Yield Bonds In January
Over the past 29 years, U.S. high-yield bonds have returned an average of 1.76 percent in January, according to the JPMorgan data cited by Azous. Of course, seasonality is not a guarantee of future returns; for instance, over that period, December was the third-best month for junk bonds.
HYG traded a record $2 billion in the secondary market last Wednesday following a day of elevated volume in traditional trading. HYG's secondary market volume soared to $4.3 billion last Friday, according to BlackRock data. However, some of that volume included, not surprisingly, increased borrows of HYG shares by short sellers. Thing is, those short sellers could be punished if they are not careful.
‘Wrong Way First’
“Collectively, if you believe in relief or counter-trend trading, these make for classic 'Wrong Way First' (‘WWF’) trades come January 1. For those not familiar with this term, WWF refers to the risk the professional investment community is exposed to at the beginning of every New Year – that is, the first trade will be a reversal in the consensus positioning and that will inflict severe PnL duress,” added Azous.
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