Tuesday, April 28, 2009

High-Yield Bonds and Market Sentiment

In recent posts, I've emphasized that the performance of more speculative, growth-oriented sectors vs. more established blue chips acts as a nice sentiment indicator for the stock market. Other sentiment indications can be derived from the performance of other asset classes.

Above we see HYG, the ETF for high-yield bonds. When economic assumptions and sentiment are favorable, these speculative bonds offer superior returns. When sentiment regarding the economy is bearish, investors will shy away from lower-rated bonds and seek the safe haven of Treasuries.

Notice how the average daily volatility of HYG skyrocketed in mid September with the Lehman collapse. We can think of volatility of HYG as a measure of uncertainty regarding the promise and risks associated with these bonds.

We can see that volatility has come well off its late 2008 peak, but still remains well above its pre-September levels. Like stocks, HYG has bounced well off its early March, 2009 lows; also like large-cap stocks, HYG has stalled out so far below its 4/17 highs and volatility has ticked up. In the wake of auto company woes, this is one reflection of sentiment that I'm watching closely.