As the stock market rolls over into a new downtrend, it’s worth acknowledging what’s causing the damage.
The precipitous decline in crude oil is the primary agitator, with futures dropping to $58 a barrel on Friday for the first time since the summer of 2008. That, in turn, is weighing heavily on the bonds of indebted, high-cost U.S. shale oil producers that are watching in horror as energy prices fall below their all-in breakeven costs.
Barclays Capital estimates that much of the U.S. shale industry needs crude oil near $80 a barrel to break even on a “half-cycle” basis — with a need for a 30% return above this to earn a 10% return on a full-cycle basis. Separately, the bank warned that if crude oil fell to $60 a barrel, it could trigger a broad high-yield market default cycle as these high-cost producers are forced into non-payment and debt restructuring.
With that in mind, these three bond funds are getting smashed and are worth avoiding. Moreover, as long as these funds are performing poorly, the stock market should continue to get dragged lower.
Bond Funds to Sell: SPDR Barclays High Yield Bond ETF (JNK)
As a result of concerns over energy bonds, the JNK has sliced to levels not seen since October 2013, down more than 7.5% from its high — washing away the 5.7% annual yield the fund offered at its price peak.
Bond Funds to Sell: iShares iBoxx High Yield Corporate Bond Fund (HYG)
Exposure is similar, with top holdings including paper from the likes of Sprint and Tenet. The yield is a little smaller, and the fund is demonstrating a little less volatility as it trades down to November 2013 lows.
But with the entire junk bond market in turmoil, HYG is to be avoided.
Bond Funds to Sell: Barclays Short-Term High Yield Bond ETF (SJNK)
Normally, this results in less volatility and risk since investors aren’t as exposed to changes in interest rates. For this reason, short-term bond funds like the SJNK normally move higher in very smooth, slow, stair-step increments.
But the SJNK is suffering its worst wipeout ever — falling to September 2013 levels and down 5.3% from its high — as the fund is being hit by default risk, not interest rate risk.
And with any possible credit actions happening sooner, rather than later, given the collapse in energy prices the SJNK is getting hit hard.
Bond Funds to Sell: Finding Refuge
Click to EnlargeIf you’re a fixed income investor, the best bet at this point is moving to cash or long-term Treasury bonds, which have been pushing higher over the past two-months as the drop in energy prices raises concerns about a global economic slowdown (given evidence it’s being partially driven by weaker demand for oil) as well as deflation or falling prices.
The iShares Barclays 20+ Year Treasury Bond Fund (ETF) (TLT) that I recommended to Edgesubscribers on Nov. 21 is already up more than 5% — an impressive gain over such a short time for a conservative, safe haven bond holding.