Possible source of next big market shock: Credit ETFs (JNK and HYG)

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Two weeks after the unprecedented, record Feb. 5 surge in the VIX, the historic move is rapidly fading into memory as “the dip gets bought” again: to those who correctly predicted it, like Fasanara Capital  and Eric Peters,  and those who profited from it, like Ibex Investors  and Peter Thiel, congratulations.
Now the question is which product, read ETF, will generate returns similar to the 94% bonanza reaped by those who were short the XIV ahead of its terminal implosion (the XIV will cease trading after Feb 20, with holders receiving a cash payment of its residual value, which is virtually nothing).

To be sure, numerous candidates have been proposed over the past two weeks, with two names frequently cited – certainly by this site among others – include the two big junk ETFs, HYG and JNK, whose existence is only assured as long as the structure and liquidity of the underlying cash junk bond market isn’t seriously tested, as the ETFs would spontaneously implode once the market of underlying junk bonds freezes up, something which Howard Marks has repeatedly warned about.

What is strange – as we discussed on several occasions  over the past 2 weeks – is that credit fared relatively well in the washout from the VIXplosion, widening by markedly less than various volatility models would have suggested; according to Deutsche Bank cross asset strategists, on its own the VIX spike should have been worth 56bp to IG spreads and 156bp to HY if only on a theoretical, “model basis.”

First it was the ETN called XIV. Now, if VIX stays elevated (high teens or above)
will blow up. Ready for round 2? I estimate within 10 weeks.

  • Spiking Treasury yields signal end of central-bank largesse
  • Junk bond funds suffer more than $10 billion weekly outflow

Corporate bond funds succumbed to rate fears that have gripped stocks to Treasuries.

Investors pulled $14.1 billion from debt funds, the fifth-largest stretch of redemptions in the week through Feb. 14, according to a Bank of America Merrill Lynch report, citing EPFR data. High-yield bonds lost $10.9 billion alone, the second highest outflow on record. As benchmark Treasury yields traded at a four-year high, it shook the foundations of a key support for risk assets — low rates.

“Investors don’t sell their cash bonds in a big way until they are forced to, which happens when the outflows start picking up more sustainably,” Morgan Stanley strategists led by Adam Richmond wrote in a recent note to clients.

Fund Flows

Corporate bond funds saw outflows last week

Source: BofAML, EPFR Global


h/t mark000

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