It’s almost as though Fed Chairman Ben Bernanke never uttered the word “taper” after all.
Late in the second quarter, the financial markets were hammered by Bernanke’s remark that the Fed could taper its quantitative easing policy before year’s end. Treasury yields soared in the weeks following his statement, leading to a meltdown in just about any financial asset with a yield above 2.5%.
But that situation has now been turned on its head, with substantial relief rallies in the various high-yield plays that were so popular through 2012 and the first three months of this year.
The table below shows the returns of some key income-producing asset categories from the first mention of tapering on May 22 through the market low on June 24, then from the low through July 23. Keep in mind that ETFs are an imperfect gauge of market performance because their market prices can become divorced from their NAVs during periods of extreme market stress. Nevertheless, they provide a gauge of the real-world returns that investors experience:
|Asset Class||ETF||Ticker||Return, 5/22-6/24||Return, 6/24-7/23|
|Corporate Bonds||iShares Investment Grade Corporate Bond ETF||LQD||-6.4%||3.7%|
|High-Yield Bonds||iShares High Yield Corporate Bond ETF||HYG||-5.9%||5.8%|
|Emerging-Market Bonds||iShares JPMorgan USD Emerging Markets Bond ETF||EMB||-12.6%||8.5%|
|Dividend-Paying Stocks||iShares Select Dividend ETF||DVY||-5.0%||8.3%|
|REITs||iShares U.S. Real Estate ETF||IYR||-13.1%||9.4%|
|MLPs||Alerian MLP ETF||AMLP||-5.0%||5.0%|
|Convertible Bonds||SPDR Barclays Convertible Securities ETF||CWB||-6.1%||7.0%|
|Preferred Stocks||iShares U.S. Preferred Stock ETF||PFF||-6.3%||3.2%|
While some of these categories — such as emerging-market bonds and REITs — remain far below their lows, others have quickly recouped their losses. Investors in HYG are down only 0.5% from the May 22 start date, while convertible bonds, utilities and dividend-paying stocks have moved to new highs.
This is certainly great news for anyone who held on through the downturn or, ideally, took the opportunity to add at the lows. At this point, however, the rally has likely reached the point at which investors who are thinking of buying in should wait for a better price before jumping into high yield.
First, the appeal of these asset classes in late June was that they were offering better yields than they had in months. High-yield bonds, for instance, moved from a yield spread of 423 basis points (4.23 percentage points) on May 9 to 534 basis points by June 24. But now, the rally has brought the spread back down to levels closer to where they stood early in March: 450 basis points at Tuesday’s close. The story is similar, albeit not quite as dramatic, across all of the yield plays.
Second, and more important, it’s critical to keep in mind the role Fed jawboning played in both the downturn and the subsequent recovery.
The initial selloff was touched off by fears about tapering, which mainly served to illustrate the high percentage of weak hands populating the ownership base of the higher-yielding market segments. Subsequently, Bernanke’s efforts to “clarify” his remarks (i.e., calm the markets) have been the primary driver of the rebound.
This indicates that the short-term performance of the yield plays remain dependent on Fed statements and/or the outlook for quantitative easing. This also means high-yielding assets are vulnerable not just to additional Fed-speak, but also positive shifts in incoming economic data. This could come in the form of an uptick in inflation or a surprising drop in the unemployment rate — both of which the Fed has cited as being the triggers for it to consider tapering QE.
Finally, the broader market itself is vulnerable given the combination of its strong recent run-up and a VIX that is once again back near its lows for the year. Notably, the enthusiasm about Bernanke’s clarifications isn’t shared by the Treasury market. Even as the higher-risk yield sectors have rallied, U.S. Treasury yields have only dropped modestly from a July 5 high of 2.71% to 2.52% at Tuesday’s close. This indicates that the bond market — which is generally regarded as the smarter money — isn’t sold on Bernanke’s back-tracking.
While high-yield assets have enjoyed a strong run in recent weeks, they remain on very unsteady ground. At this stage, yield-hungry investors can afford to be patient rather than attempting to milk additional returns from this rally.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.