Junk Weakness

"So, what you're telling me is the music is about to stop, and we're going to be left holding the biggest bag of odorous excrement ever assembled in the history of capitalism."
--John Tuld (Margin Call)

For the past couple of weeks, I've been thinking about high yield (a.k.a. 'junk') bonds. Junk bonds are bonds issued by companies with shaky prospects (e.g., weak balance sheets, low cash flows. They are able to sell debt only if they offer coupons at interest rates significantly higher than more credit worthy firms.

In today's 'reach-for'yield' environment, junk has been bid to the stratosphere with commensurate tightening in credit spreads, i.e., the difference between Treasury yields and junk yields. Over the past few months, junk spreads have been tightening to historic lows.

That Little Voice has been telling me that it is time to keep half an eye on junk spreads for signs of widening. Widening spreads would suggest declining appetite for extreme risk among market participants.

Today, ZeroHedge reports some weakening in high yield credit markets. Relative to stocks, high yield is trading heavy:

And we're starting to see some outflows from junk bond funds:

Nothing huge, but worth watching. The real test will be credit spreads. If junk spreads start blowing out then heads will turn and eyes will focus.

position in SPX