High yield bonds decline amid outflows from mutual funds
Corporate credit markets were mixed this week as U.S. government bond yields rose to a four-year high, equities recovered some lost ground and high yield bond mutual funds recorded their largest weekly outflow in more than three years.1,2,3 High yield bond prices rose toward week’s end as equities rallied and U.S. Treasuries stabilized.4 Nevertheless, high yield bonds recorded their third consecutive weekly decline and are on pace for their first monthly decline since November.4 Alongside a 14 basis point rise in U.S. 10-year Treasury yields, high yield bonds are providing returns of approximately -1.36% in February.1,4 Against the backdrop of this month’s selloff in U.S. Treasuries, the higher-yielding areas of the bond market are holding up slightly better than their lower-yielding peers. Month to date, BB rated bonds are providing returns of -1.54%.5 By comparison, B rated and CCC rated bonds are providing returns of -1.14% and -1.32%, respectively.6,7 This week, high yield bond mutual funds recorded an outflow of $6.3 billion, the fifth consecutive weekly outflow and the second-largest weekly outflow on record.3 The year-to-date outflow now stands at approximately $13.7 billion after investors withdrew approximately $21.3 billion from high yield bond mutual funds in 2017.3
Senior secured loans post year-to-date gains
While February’s decline in high yield bond prices has weighed slightly on the senior secured loan market, senior secured loans recorded a modest gain this week and remain one of the few fixed income investments providing a positive return in 2018.8 Benefiting from their floating rate coupon and position as a potential hedge against rising interest rates, senior secured loan prices have continued to appreciate since the outset of 2018 even as high yield bond prices declined.8 For context, senior secured loan prices are up $0.58 since December 31, 2017, as increased interest rate concerns have possibly raised the appeal of the asset class, versus a $1.47 decline for high yield bond prices.4,8 Year to date, senior secured loans are now providing returns of 1.05% after returning 4.25% in 2017.8 By comparison, high yield bonds, investment-grade bonds and U.S. 10-year Treasuries are providing a year-to-date return of -0.73%, -1.58% and -3.97%, respectively.4,9,10
CPI signals firming inflation
The combination of increased U.S. equity volatility and rising U.S. government bond yields made Wednesday’s consumer price index (CPI) data particularly important for investors. Bond investors had tightened their focus on inflation data after the Labor Department report earlier this month signaled rising U.S. wages and were looking for confirmation that inflation is firming.11 Overall, this week’s CPI report showed inflationary pressures intensifying somewhat in January, with headline prices rising 2.1% during the preceding 12 months, while core CPI prices rose 1.8% over the same period.12 The higher-than-expected rise comes five weeks before the U.S. Federal Reserve’s next policy meeting on March 20–21 and has boosted expectations that the central bank may adjust its guidance from three interest rate hikes in 2018 to four.13,14 Investors are now pricing in a roughly 20% chance of four rate hikes in 2018, up from just a 10% chance at the beginning of the year.14 While the U.S. CPI data offered fresh evidence that inflation is picking up, a few components of the CPI report are thought to be aberrations and the Fed may wait for further confirmation.15 Apparel prices, for example, rose 1.7% in January, which was the largest monthly increase since February 1990.15 While yields at the front end of the curve continued to test decade-long highs, long-end Treasury yields remain near historic lows and the five-year, five-year forward inflation expectation rate, a market-based measure of inflation expectations, remains at just 2.27%.16,17,18
Chart of the week: Recent fund flows highlight the benefits of a long-term focus
- U.S. equity markets enjoyed a relatively steady rise throughout 2017 and into early 2018. The S&P 500 Index returned nearly 22% last year and largely continued its momentum in the first weeks of this year. In January 2018, for example, U.S. stocks returned approximately 5.7%, their highest monthly return in nearly two years.2
- Investor sentiment steadily moved higher along with the stock market. One measure of sentiment, the ratio of bullish to bearish investors, reached 5.24 in late January, its highest point in more than two decades.19 However, it is precisely these types of market environments that may lead to periods of significantly higher volatility.
- Amid their enthusiasm, for example, investors poured more than $17 billion into U.S. equity mutual funds for the week ended January 24.3 It was the second-largest weekly inflow into U.S. equity mutual funds since November 2016, just after the U.S. presidential elections, and was global stocks’ sixth-largest inflow ever.3,20
- Just two weeks after the significant January inflow, investors pulled nearly twice as much back out of U.S. equity mutual funds, $28 billion, as the U.S. equity market was on its way toward a brief correction.2,3 As the chart highlights, investors are often poor market timers.
- Emotions, or sentiment, can often get in the way of investors’ ability to make the best long-term investment decisions. As we have seen, volatility can spike very quickly and without notice, so it is critically important that investors become proactive and prepare for it rather than react after it hits.
1 Federal Reserve Bank of St. Louis, 10-year yield, http://bit.ly/29ecBfp.
2 Federal Reserve Bank of St. Louis, S&P 500, http://bit.ly/2d3pN5b.
3 Thomson Reuters Lipper.
4 ICE BofAML U.S. High Yield Master II Index.
5 ICE BofAML U.S. High Yield BB Rated Index.
6 ICE BofAML U.S. High Yield B Rated Index.
7 ICE BofAML U.S. High Yield CCC & Lower Rated Index.
8 Credit Suisse Leveraged Loan Index.
9 ICE BofAML U.S. Corporate Master Index.
10 ICE BofAML U.S. 10-year Treasury Index.
11 U.S. Bureau of Labor Statistics, http://bit.ly/2iYbHWM.
12 U.S. Bureau of Labor Statistics, http://bit.ly/2jKLr2f.
13 U.S. Federal Reserve, http://bit.ly/29y0IjN.
14 Bloomberg, based on CME data.
15 Dow Jones Newswires, http://bit.ly/2Cq56g4.
16 Federal Reserve Bank of St. Louis, 2-year yield, http://bit.ly/2anGvQ0.
17 Federal Reserve Bank of St. Louis, 30-year yield, http://bit.ly/29ecFfc.
18 Federal Reserve Bank of St. Louis, 5-year/5-year forward, http://bit.ly/2syTZBG.
19 Yardeni Research, based on data from Investors Intelligence (figure 9), http://bit.ly/2tK0xxU.
20 Bloomberg, https://bloom.bg/2Bd2f9Z.
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