Is It Just the News or Did the Trend Move to Risk Off on Valuation?

Bond buyers are showing nervousness about junk bonds and debt from emerging market countries, but MoneyShow’s Jim Jubak questions if the trend is a risk off move in reaction to global tension or the sign of a temporary peak.

Is it risk off time in the bond market?

Looks like it so far in July as bond buyers are showing nervousness about junk bonds and debt from emerging market countries.

The shift is clearest in the junk bond market.

In the ten months through June, high yield—or junk bonds—showed a total return of 10.4%.

Since then, yields on junk bonds have climbed and prices have dropped. US high yield bonds have climbed to a yield of 5.94% from a record low of 5.69% on June 23, according to Bank of America Merrill Lynch. The worst damage has been at the longest maturities. Junk bonds maturing in five years, or less, have lost 0.4% so far in July. The overall US junk-bond market is down 0.63% in July, according to Bank of America Merrill Lynch.

Those fears and those losses are reflected in outflows from high yield bond funds and ETFs. For example, last week, Bloomberg reports, investors pulled $607 million from Pimco’s 0-5 Year High Yield Corporate Bond Index ETF. That’s the biggest cash outflow in the ETF’s three-year history.
 
In the market for emerging market debt, the nervousness so far is anecdotal. After international sales of bonds from emerging market governments hit $69.7 billion in the first six months of 2014—a 54% increase from the first six months of 2013—Wall Street analysts have started to talk about a repeat of last summer’s Taper Tantrum, when fears of the end of US Federal Reserve’s $85 billion a month in purchases of Treasuries and mortgage-backed securities led to a sell off in both emerging market stocks and emerging market debt. As measured by the iShares MSCI Emerging Markets ETF (EEM), emerging market stocks fell by 8.46% from May 3 to June 18. Emerging market debt, as measured by the iShares JPMorgan Chase Emerging Markets Bond ETF (EMB) dropped harder, falling by 12.02% from May 13 to June 20.

It’s not surprising to see a move toward risk off in the markets after a week of horrible news from Gaza and Ukraine ratcheted up global tensions. It will be important to note if the risk off trend continues even as—supposing it does—news from these areas gets less worrying.

In other words, is the risk off move simply a reaction to bad news or is it a sign that investors and traders think junk and emerging market debt have hit a temporary peak?