Analyst: Junk Bond Bubble is About to Burst

junkMike Burnick: When it comes to investing, I put my faith in the numbers, the cold hard facts. That’s why I prefer quantitative and technical analysis over fundamental.

Based on decades of experience, I’ve learned to pay more attention to what investors are actually doing with their money, instead of what they’re saying in the Wall Street Journal or on CNBC.

Talk is cheap, but following the trail of cold hard cash tells you whether or not investors are putting their money where their mouths are.

That’s why I focus on money flows for both stocks and, especially, ETFs. These flows tell you where investors are really committing their capital, and more importantly, they can signal when the tide is turning.

In a world of near- or sub-zero interest rates, investors have been desperately seeking income anywhere they can find it. Even in asset classes that used to be considered high risk. Case in point: Investors have been jumping into junk bond ETFs with both feet over the past few years. You can see it in the numbers.

Investments with at least some yield have been in demand in this near- or sub-zero rate environment.

The iShares High Yield Corp. Bond ETF (HYG) has attracted $3.3 billion in net cash flows from investors over the last three years; $1.9 billion of that has flowed into HYG just so far this year.

Meanwhile, over the same time frame the SPDR High Yield Bond ETF (JNK) enjoyed net inflows of $3.6 billion, with $2 billion in buying year-to-date.

And you can see why investors are suddenly in love with junk. With Treasury bonds yielding less than 2% today, what’s not to love about the 6% yield offered by JNK.

But how many of the investors who shoveled billions into this ETF ever stopped to think the price could easily fall 6% in a week or less, wiping out all their hard-earned income, and then some?

What’s the lesson to be learned? Well, don’t reach for yield, of course. That’s the easy one, but there’s another more important lesson.

“Fund flows are nothing more than a popularity contest.”

Fund flows are nothing more than a popularity contest. And the ETFs voted most popular in terms of hot money flows last year aren’t necessarily the ETFs most likely to succeed going forward.

Huge inflows over a long period, say one to three years, are a sign that you’re late to the party. The big upside move for an ETF, fueled by all that hot money, may be almost over. Worse, the tide may be about to reverse.

Sure enough, taking a closer look at recent ETF fund-flow data from Bloomberg over the past 30 days reveals a very different picture.

Over the past month, $882.4 million has flowed back OUT of JNK, and another $673.1 million in cash has been yanked from HYG. So is the party over?

Here’s an interesting piece of corroborating evidence: Moody’s reports that the U.S. speculative-grade (i.e. junk debt) default rate stood at 5.1% in June, the highest level since August 2010, and above the average rate of 4.2% since 1983!

So let’s summarize:

CheckmarkJunk bond ETFs have attracted record amounts of dumb-money cash flows from yield-starved investors …

CheckmarkThese are still among the best-performing ETFs year-to-date, but money is now flowing out, indicating the tide may already be turning …

CheckmarkJunk bond default rates are rising to the highest level in nearly six years …

What could go wrong? Junk bond buyers beware.

The iShares iBoxx $ High Yid Corp Bond ETF (NYSE:HYG) rose $0.05 (+0.06%) to $85.84 per share in premarket trading Friday. The largest junk bond ETF by assets under management has gained nearly 6.5% year-to-date, as investors continue to clamor for yield amid record low interest rates.


HYG currently boasts around $17.4 billion in assets under management. The ETF, which offers exposure to a wide range of high-yield corporate bonds (many of which are below investment grade), has regularly topped the list of ETFs with the highest weekly inflows this year.

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