Why I Will Likely Be A Buyer Of High Yields

David Fabian

Every correction in the stock or bond market unfolds in a different manner.  While our natural inclination is to try and make comparisons to prior events or rationalize statistical probabilities for a turn, there is no easy way to know when an investable bottom has truly materialized.market trend

From a valuation perspective, cheap can always get cheaper…until it goes to zero.  Similarly, from a technical perspective, lines of support can always be broken by new trends or forces that materialize in the midst of a decline.

In recent years, it has become commonplace for sharp rallies or “V-bottoms” to form with very little notice to those who aren’t quick on the trigger.   These are generally caused by capitulation near the low as sentiment reaches extreme negative readings.

This fear ultimately leads to a snapback in price as an unforeseen catalyst sparks a rubber band effect.

junk bondsThe problem is that it isn’t easy to time these events.

Let me give you an example.  Last year I wrote about the downtrend in junk bonds, as risk averse investors were jumping ship at a breakneck pace.  I prophesized that I would be a buyer of high yield in 2016 for my clients to take advantage of the widening spreads and relative valuation metrics.

That type of premise looks prescient when you are sitting on the sidelines watching the iShares iBoxx High Yield Corporate Bond ETF (HYG) crater with cash to deploy.

DF graph

However, it becomes much more difficult to execute in real life prior to a sharp 10% rally that unfolds in a matter of just three weeks.  I fully admit that we missed this opportunity.  It may have been the result of being overly cautious or simply remaining skeptical that such a voracious move could materialize so quickly.

marketsFortunately, we still have other risk assets in the portfolio that are able to meaningfully contribute to this recovery in the stock and credit markets.

The conservative nature of our investment mandate dictates that I would rather look back with regret on a potential missed opportunity, than suffer the consequences of an overly aggressive stab in the dark.

We only know in hindsight how this picture unfolded and of course have yet to determine what the ultimate resolution will be.

The question now becomes: was this an intermediate-term low, or simply the result of an oversold asset demonstrating a sharp ramp that will ultimately fall apart over the coming months?

There is no way to know with certainty what the outcome will be in the future.  However, you do have a few options to consider when you’ve missed the boat on a big move:

  1. Buy anyways. It may seem silly to buy after a big run, but there is no law saying that a fund like HYG can’t move all the way back to its prior highs near $87.  There is still another 8% of overhead space between its current price and that level.  I’m not saying that event will occur with a high conviction, but you can’t rule it out either.
  2. Break up your allocation in pieces. Another way to play this opportunity is to break up your trade in smaller pieces.  If you were planning on a 5-10% allocation, you may be able to break that into two or three parts in order to allocate equally over time.  That gives you the flexibility to participate if the new trend continues without the all-in risk that you face in a single trade.  Of course, the drawback is that you will wish you had just gone with the whole allocation if this succeeds.  Transaction-free ETFs make for a very effective tool to accomplish this task.
  3. Have patience. There is nothing wrong with sitting and watching either.  Time is on your side if you have been carefully managing your exposure and have other risk assets that are participating in the upside move.  You may want to wait and see if some of the momentum gets worked off and this sector retraces a portion of its recent strength.  Watching for a higher low to develop may be a potential entry opportunity that is waiting in the wings.
  4. Move on. My grandfather was early to the trend following philosophy four decades ago and used to tell me that “lost opportunity is better than lost money”.  There is no doubt that both are equally frustrating.  However, history has proven that there will always be fresh opportunities in the market that are simply waiting to be sniffed out.  Putting one in the rear view mirror allows you to focus on new themes that may just be peaking over the horizon.  Spending too much time on “shoulda, coulda, woulda” criticism is a drain on your time and resources.

urlThose with the longest time horizons are typically best served by using weakness to their advantage in order to buy at lower prices and reap the rewards of long-term growth.  Conversely, those with short-term time horizons are often jumpy to try and sidestep every drop or driven to leap at new possibilities before they have adequately proven themselves.

I am optimistic that we will still get our shot to re-allocate more direct exposure to high yield credit at a time and price that suits our philosophy.  A little patience now will likely pay off in spades as we continue to navigate our way through these choppy markets.


Until next time,

David Fabian

David Fabian is a Managing Partner at FMD Capital Management, a fee-only registered investment advisory firm specializing in exchange-traded funds. He has years of experience constructing actively managed growth and income portfolios using ETFs. David regularly contributes his views on wealth management in his company blog, podcasts, and special reports. Visit www.fmdcapital.com to learn more.