Is The Rout In Junk Bonds Driving The Nasdaq Rally?

Authored by Ven Ram, Bloomberg cross-asset-class strategist,

Amid rising real and nominal yields, the S&P 500 Index has more than surrendered its gains of January in a easy-come, easy-go fashion. But there is an odd thing going on elsewhere: why would technology stocks not only hold onto their advance but also build on them?

You could talk about long duration, growth and blah, blah, blah, but the likely reason is that the rout in corporate junk bonds is sending high-risk, higher velocity and the highest speculative dollars right into the Nasdaq 100. If you had thrown all caution to the wind and parted your money in favor of the technology basket at the end of last year, you would have stunning returns of almost 12% in less than two months.

In the chamber next to where the Nasdaq dream is being spun a nightmare is playing out in junk bonds.

The yield-to-worst on the Bloomberg US corporate high-yield index is now approaching 9%.

By way of perspective, consider that the highest that number got to in recent memory was during the first wave of the pandemic when it reached 11.7% – so essentially the markets are now pretty much near panic.

If you needed further proof, just look at the money coming out of high-yield bond funds.

(Hat tip to Abigail Doolittle for the chart)

That script is, alas, not playing out as expected. At the start of the year, the cue lines were that inflation was so 2022, that a recession is around the corner and the Fed would panic and pivot immediately. Evidently it’s the investors who are in panic now, not the monetary authority.

But is that speculative money jumping from the frying pan into the fire by following the beeline to technology stocks?

Just consider this: at current levels, the Nasdaq 100 basket offers an earnings yield of 3.8%, which if you are in a benevolent mood may raise to 4.3% based on estimates for earnings that are yet to accrue this year — a bit like a farmer counting on his future produce on the hope that the sun will shine, the rains will come as foretold and the harvest will occur as he hopes.

In any case, let’s split the difference and assume an earnings yield of, say, 4%. But right now, if you go out and buy a one-year T-bill in the US, you would get about 5%.

If you think the US economy will roll over within that time frame, it’s a pretty safe bet that the T-bills will rally, and at least you wouldn’t have exposed your portfolio to the vagaries and idiosyncrasies of technology stocks. What’s not to like? Ask those chasing the Nasdaq rally.