The Zacks Analyst Blog Highlights: iShares High Yield Corporate Bond ETF and SPDR Barclays High Yield Bond ETF

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Dec 16, 2014, 09:30 ET

CHICAGO, Dec. 16, 2014 /PRNewswire/ -- Zacks.com announces the list of stocks featured in the Analyst Blog. Every day the Zacks Equity Research analysts discuss the latest news and events impacting stocks and the financial markets. Stocks recently featured in the blog include the iShares High Yield Corporate Bond ETF (AMEX:HYG-Free Report) and SPDR Barclays High Yield Bond ETF (AMEX:JNK-Free Report).

Today, Zacks is promoting its ''Buy'' stock recommendations. Get #1Stock of the Day pick for free.

Here are highlights from Monday's Analyst Blog:

Junk Bond ETFS – Victims of the Oil Crash?

Junk bonds have been among the major victims of the 40% plunge in oil prices in recent months. These bonds with low credit ratings and high yields now appear to be on track to deliver their worst annual performance in the past six years.

How are Oil and Junk Bonds Related?

The steep decline in the high yield space has mainly been caused by the panic selling of energy bonds. Energy boom of the recent years led to a surge in borrowing by energy companies, particular those in shale exploration. Energy securities now comprise about 16% of the high yield bond market, up from 4% about a decade back. And about 18% of high yield energy bonds are currently trading below their face value. (Read: 3 Country ETFs Crushed by the Oil Crash)

Widening Spread Between Treasury and Junk Bonds

The slide in oil prices is partly due to weaker-than-expected demand, which basically reflects slowdown in the global economy and encourages investors to pile into safer assets. As a result, Treasury bonds have benefited from their safe haven appeal. Looming supply glut and a surging dollar has further added to the commodity's woes.

The spread between Treasury and high yield bonds is currently close to 5.5% compared with 3.6% about four months back, meaning that high yield bond investors now demand 5.5% more yield than for comparable Treasury bonds in order to compensate for the risk.

While the broader high yield sector has a yield of around 6%, energy bonds currently yield about 9%. (Read: 3 Apple Focused ETFs to Bet on for the Holiday Season)

Any Overlooked Risks in the High Yield Space?

Continued slide in oil prices may lead to some defaults and restructurings, and further sell-off in the energy high yield space. In recent years, this space had expanded rapidly thanks to investors' insatiable appetite for yield in the rock-bottom interest rate environment.

And with low defaults, the yield spread over Treasuries shrank. While the spread had climbed to as high as 21% in December 2008 due to severe stress in the market, in the recent past it has remained rather low. These factors had led to a surge in issuance of low quality paper.

Another reason to be cautious on the high yield space is the liquidity risk. Total face value of bonds in the Bank of America Merrill Lynch global high yield index was $1.9 trillion at the end of 2013, up 130% over five years but the market remains rather illiquid.

Given the rising quantity of lower quality debt, this market is becoming more risky. Illiquidity further makes market more prone to steeper declines in times of stress. (Read: Semiconductor ETFs Riding High on Holiday Optimism)

Is the Sell-Off Overdone?

Funds holdings junk bonds have seen huge outflows in recent weeks. iShares High Yield Corporate Bond ETF (AMEX:HYG-Free Report), which has 13.6% exposure to the Oil & Gas sector, has lost 5.6% in the past six months. Another popular high yield ETF—SPDR Barclays High Yield Bond ETF (AMEX:JNK-Free Report) is down almost 7% during the same period.

Despite steep declines, buyers are very hesitant to step in as risks in the space may still outweigh future rewards.

At the same time, with interest rates expected to stay low for some time, the demand for high yield may stay elevated. And default rate may still remain low next year given that most of the high yield debt doesn't not mature till 2017, per Fitch.

Is the selling in the high yield bond space overdone? Probably yes, but buying the broader market fund is advisable only after oil prices find a bottom. Some of the high yield bond issued by stable companies in other sectors not affected by oil may be worth a look at these levels.

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