Junk vs. Investment Grade Bonds, What Does the Divergence Suggest for Equities?
by ilene - May 26th, 2010 2:34 pm
Junk vs. Investment Grade Bonds, What Does the Divergence Suggest for Equities?
Courtesy of Mish
Minyan Harvey is inquiring about the divergence between junk bonds as measured by JNK and higher grade corporates as measured by LQD.
The question is in regards to Corporate Bonds Smacked, Junk Yields Rise, Deals Pulled; Treasuries Rally; Yield Curve Flattens; Global Slowdown Coming
Minyan Harvey writes …
Prof. Shedlock (or is it Prof. Mish),
Hope you are well. Just read your post in Buzz & Banter about JNK in particular and high yield corps in general. I see all of that and it confirmed what I thought the junk market was telling us. However, one thing confuses the heck out of me, and I hope you can clear this up. Why is the investment-grade market (LQD) seemingly holding up so well? In 2008, the LQD fell throughout the year and slightly led the equity market down in the waterfall decline. Yet LQD is actually HIGHER year-to-date and up ever so slightly since the April top in equities.
What gives? If we are headed for another 2008 waterfall, shouldn’t the LQD be showing signs of stress?
I defer to you as I am anything but an expert on corporate bonds. Thanks for your time and answer.
Peace,
Minyan Harvey
Hello Minyan Harvey, just plain "Mish" is quite fine. Thanks for asking.
In regards to the divergence you spotted, Rot is most often visible at the edges first. The same applies to both bonds and equities:
Consider Europe. The weak link was Greece, but the concern about rot quickly spread to Portugal, then Spain. I think that concern will spread to Italy as well.
In equities, the first visible crack something was amiss in the global recovery thesis was China and emerging markets, not the US. Note that the Shanghai index $SSEC led the recovery then was the first to correct. Europe followed, now the US.
$SSEC Weekly Shanghai Index
Likewise, in regards to corporate bonds, it would be normal for rot to appear first in junk.
Also note that in 2008 continuing into March of 2009 there was indiscriminate selling of everything in the corporate bond world. Bond prices reflected Armageddon that did not happen, even if in some cases it should have and would have without government intervention, as is the case in Fannie Mae…