Last week investors pulled $6.8 billion from high-yield bond funds last week, the third-biggest outflow on record. Several factors contributed to the outflows including worries about the sustainability of yields at multi-year lows, rising interest rates, China worries and concerns surrounding struggling US tax legislation.
However, while bond funds suffered outflows, investors snapped up equities. Equity portfolios added $3.2 billion, with tech funds recording their second-biggest ever inflow according to data from Bank of America.
Investment -grade bond funds also recorded significant inflows. Funds holding investment grade securities recorded inflows of $4.8 billion, the 47th straight week of inflows according to BoA.
Many believe that this junk bond sell-off has been long overdue. The yield on junk bonds rose above 6% for the first time since March last week, slightly above the three-year low of 5.4%, which is arguably far too low.
Junk Universe Sell-Off
As the Financial Times reports, investors seem to have been spooked by weak results from US telecoms, which make up around $300 billion of the $1.3 trillion US junk universe. News that Sprint and T-Mobile would abandon merger talks, and lackluster earnings from CenturyLink, Community Health Systems, and Frontier Communications sent prices of telecom junk bonds sliding by 3.3% since the start of November.
However, despite these concerns, Wall Street analysts do not expect a sudden surge in bankruptcies. Analysts with Moody’s expect the US default rate to drop from 3% this year to 2.1% by the end of 2018.
Indeed, Bernstein's analysts note that the sell-off has been relatively limited to just a few names in the junk universe, which is skewing the overall trend. In a recent report, analysts note half of the entire sell-off can be attributed to 4 out of the 100 names in the index, and 80% of the decline is due to only ten companies. Investors have been bailing out of these bonds for some time.
The analysts go on to speculate that, as there are no other signs of market contagion, this is more of a quality trade. Leveraged stocks have underperformed recently, coinciding with the junk sell-off, while at the same time, there has been no sign that investors are fleeing to quality as investment grade moves have been modest.
As interest rates remain low, and the US business cycle remains firm, the team at Bernstein does not believe that leverage will be a market headwind for much longer.