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The Independent Adviser for Vanguard Investors
•
March 2016
•
5
FOR CUSTOMER SERVICE, PLEASE CALL
800-211-7641
I don’t believe there is much news
that isn’t already built into the prices
of most high-yield bonds at this point.
Oil has already come close to touch-
ing $25 per barrel. Frackers and their
ilk have already shut down wells and
begun the process of trying to work out
their debt loads. Unless there is another
huge downtick in the price of oil, which
I can’t really see happening, most of the
bad news is, as I said, already built into
junk bond prices.
This bad news is reflected in the
yield you are being paid—High-
Yield Corporate’s 6.56% SEC yield is
5.42%, or 542 basis points, more than
Intermediate-Term Treasury
’s 1.14%
yield. The black line in the graph to
the right shows this difference in yield
(or spread) over the past 22 years. As
you can see, spreads have only been
this wide on three other occasions in
the past two decades: 2002, 2008–09,
and 2011 (when I first purchased the
fund in the
Model Portfolios
). It is
When High Yield’s Spread Is
High, Excess Returns Follow
Spread over Int-T. Treas.
Excess 12-mo. return
1/94
1/96
1/98
1/00
1/02
1/04
1/06
1/08
1/10
1/12
1/14
1/16
0
200
400
600
800
1000
1200
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
certainly possible that spreads could
widen further (it happened in the credit
crisis), but when spreads have reached
this level in the past, you’ve wanted to
be buying high-yield bonds, not sell-
ing. The blue line on the chart shows
the difference in performance between
High-Yield Corporate and Intermediate-
Term Treasury over the ensuing year.
On average, High-Yield Corporate out-
performed Intermediate-Term Treasury
by 9.2% in the 12 months after spreads
were over 500 bps.
There may be some more short-term
pain to come, but if you’d bought High-
Yield Corporate at these levels in the
past, you probably felt pretty darned
smart about it if you held on. I’m stick-
ing with High-Yield Corporate for the
moment, and suggest you do, too.
n
IT’S THE TALK
of the financial cable
news shows and various publications
and blogs, but the current accepted
wisdom is simply wrong.
Stock prices and oil prices are not
highly correlated, and to make a big
deal over a few weeks of trading is non-
sense. While we’ve seen a bit higher
correlation between the two recently,
over virtually any period of time longer
than it takes for a stock trader to spew
such silliness, stock markets and oil
prices have shown an average correla-
tion of around 7% to 10%. That’s a far
cry from 100%. Take a look:
First, here’s what’s happened over
the past few months, on a daily basis.
The left-most graph below shows each
day as either 100 (both stocks and oil
move in the same direction for the day)
or -100 (stocks and oil move in differ-
ent directions).
Since the end of June 2015, stock
prices and oil prices have moved in the
same direction on 112 days, or 65% of the
time. That’s a pretty high correlation, but
nowhere near 100%. The number rises a
bit in the first two months of 2016, when
over 40 trading days, stocks and oil moved
in the same direction 75% of the time.
But let’s take the calculation out
just a little bit further to determine the
strength of this supposition that stock
and oil prices move together. I looked
at rolling five-day periods just since the
end of 2015, and the average correla-
tion drops to 45%! But take the data out
a bit further, say more than 25 years,
and the average correlation over five-
day periods drops to an 8% average!
The same thing happens when you
look at longer periods of, say, correla-
tion over 100 days or 250 days or even
20 days. Correlation, on average, drops
to a meaningless level—about 7%.
CORRELATION
Oil and Stocks in Sync—Not!
Daily Oil-Stock Co-Movement
(S&P 500, Brent)
6/15
7/15
8/15
9/15
10/15
11/15
12/15
1/16
2/16
-100
0
100
>
Rolling 100-Day Correlation
(S&P 500, Brent)
2/89
2/92
2/95
2/98
2/01
2/04
2/07
2/10
2/13
2/16
100-day
Avg.
-100%
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
Rolling 250-Day Correlation
(S&P 500, Brent)
2/90
2/92
2/94
2/96
2/98
2/00
2/02
2/04
2/06
2/08
2/10
2/12
2/14
2/16
250-day
Avg.
-100%
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%