Spy vs. Spy (HYG)


Executive Lounge, Wall Street Elite / Wednesday, March 9th, 2016

We once imagined a story-line for a movie we were certain would make a runaway box office hit. It pitted a pair of politicians running for President, but unbeknownst to all but the two – they were both spies!

 

One was a Russian agent, blonde, good looking and funny, the other a Mexican charmer, charismatic and debonair. The two hated America desperately, but put on a hell of a show to win their respective parties’ nominations before moving on to the national battleground.

 

The theatrics of the story, not to mention the irony – with the audience knowing that everything was not only staged and insincere, but outright diabolical – we believed would create an atmosphere of piano wire tension, as well as the potential for humor unlike any other cinematic event since Chaplin’s Great Dictator.

Hitler

Both leaders worked throughout the film, on the one hand, to earn the love of a lamb-like electorate, and, on the other, to deliver those same innocents to the wolves of their own nations.

 

Relevance?

 

First, we offer the idea for anyone who wants it. Go ahead – write the damned thing, call the hero Huey if you like, and make yourself a bundle of money. Then give us some.

 

But consider, too, that the current theatrics playing out on the national stage are nothing more than a similar diversion from the real, daily battles that we’re all experiencing and that genuinely threaten our health and welfare.

 

We’re going to focus, as we always do, on the financial health and welfare aspect, but as for the rest – look after yourself.

 

Noise, Diversions and Worry

 

While the entire world is fixated on Donald Trump’s ‘fascism’, Hillary’s felonies, Field Marshal Putin’s Syrian bombing runs and the Chinese slowdown, the market is climbing.

 

Has there been a time in the last fifty odd years – maybe since the Cuban Missile Crisis – that so much uncertainty prevailed and so much seemed at stake?

 

If there was, we can’t remember it. Watergate and Vietnam maybe, but this appears a whole lot graver.

 

And that’s precisely why the best investing advice we can offer is to be long equities.

Nobody Excited

Because the show that’s currently providing cover for the market’s rise – a rise that will ultimately create the greatest bull run in the history of investing – will not conclude before the ‘American Coronation’ in November. And it’s possible that a greater intensity in the Middle East conflict will come in the summer months, providing even more smoke for the ongoing stock levitation.

 

Will it go up forever?

 

Now, we recognize that at some stage the market will stall, but it won’t happen with sentiment figures like those we have now (see above). Nor will it happen until everyone everywhere is focused like a fish on the tremendous gains to be had from stock investing. When the headlines of your local newspaper start blaring incessantly about the riches to be had from Facebook shares, it will be time to look elsewhere.

 

Until Then…

Cartoon

Buy Facebook shares.

 

Signs of a Sharp Move Higher

 

This week, we’re looking at an indicator that we believe points toward a continued advance for the indexes.

 

We’re going to delve into the world of high yield (junk) bonds, with an eye toward understanding how these instruments can be used in a forecasting role.

 

We’ll start with a look at the iShares iBoxx High Yield Corporate Bond ETF (NYSE:HYG), the most representative, liquid and popular ETF in its class.

HYG technical

Two things are immediately evident from the chart. The first is just how poorly the junk sector has been doing over the longer term, evident from the fully unfurled, down-trending moving averages and the twice oversold RSI readings in just the last six months (in blue).

 

At the same time, the recent burst higher has cast the asset class in a new light, with many wondering if the selloff was overdone, corralled by folks of a more speculative bent, who were counting on massive losses in the oil sector contributing to a greater number of defaults than expected from HY overall.

Crude oil

As it turns out, much of the worry over oil has diminished of late, with crude’s would-be recovery. Oil has jumped from $28 a barrel to a steady $38 in under a month. And as the chart above shows, could rise to $40+ before encountering resistance.

 

Some have suggested that the rally in oil is a short squeeze initiated by none other than the banks, in an effort to make it easier for distressed oil producers to either issue new credit or equity, and avert the inevitability of industry-wide defaults – a development that would put those same banks into a whole heap of trouble.

 

Could it be?

 

It’s possible.

 

But it’s not relevant, because it’s price and volume that matter to us; so the group that’s doing the buying is less of an issue.

 

What is certain is that a full $9 billion in new fund flows have entered the high yield space in just the last two weeks, bringing the current total invested in the sector to just under $1 trillion, as the following graphic reveals.

pie charts

Also evident from the above is how small a component HY energy sector issuance is (reds) relative to the whole.

 

Look now at a chart of the Merrill Lynch US High Yield Master II Index, the premier guide to junk spreads off Treasuries.

FRED Chart

As you can see, junk is now as cheap as it has been any time in the last decade, outside the Lehman Bros. meltdown of late 2008. With spreads currently at 750 bps over Treasuries, the time is ripe to be a buyer of high yield.

As readers of this space know, we’re big proponents of the ‘Buy Wide, Sell Tight’ approach to the junk sector. And we’re confident spreads are as wide as they’re going to get for a while.

 

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Wall Street Elite recommends you consider buying the HYG June 79 CALL for $2.62 and sell the HYG June 81 PUT for $2.73, for a total credit of $0.11.

 

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With kind regards,

 

Hugh L. O’Haynew

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