The pullback in equities in the U.S. has been quite orderly, in contrast to the volatility in some of the other asset classes, most notably emerging markets and Japan. But the high yield credit sector, a long-time favorite of those seeking yield, has also seen some severe selling in the past few weeks, another crowded trade getting a bit of a gut check.
Here is the 4 year chart of a 5 year high yield credit index (higher means tighter yields and better performance for owners):
I used the high yield credit index because I wanted to get a picture that was independent of the absolute level of rates (many who look only at the high yield ETFs, like HYG or JNK, are mixing credit with rates). So the selloff we have seen in high yield credit is the most severe of 2013, but it is still in a longer-term uptrend, and still comfortably higher in 2013.
One big reason for investors favoring high yield has been the continued low default rate among high yield corporates. This pullback seems like another normal shakeout of positioning given little increase in defaults. It’s also in part due to the move higher in rates markets as a whole, which tends to reduce the appeal of higher yield assets simply on a relative comparison. That’s different than the selloff in the past few weeks in emerging market credits, which have more financial leverage, and oftentimes more operating leverage as well. Emerging markets continue to be under more pressure from an economic standpoint as well.
In the meantime, keep an eye on a stabilization and turnaround of high yield for a sign of renewed risk appetite across financial markets as a whole.