Trading Nation

A so-called ominous sign for stocks is nothing to sweat — yet

A so-called ominous warning sign for stocks is nothing to sweat — yet
A so-called ominous warning sign for stocks is nothing to sweat — yet

The high-yield market has underperformed equities this year, often seen as a sign of trouble for stocks. One portfolio manager says it's not acting as a warning for broader markets — at the moment.

Underperformance in the high-yield space is fairly benign right now, says Washington Crossing Advisors portfolio manager Chad Morganlander.

"It's all that duration risk," Morganlander told CNBC's "Trading Nation" on Thursday. "As interest rates rise, high yield is a fixed-income instrument, it actually will go lower."

That relationship has played out this year — as interest rates have risen since January, the HYG high yield corporate bond ETF has come under pressure. The yield on the U.S. 10-year Treasury note added roughly 60 basis points this year, topping the 3 percent mark this week for the first time in four years. The HYG, meanwhile, has dropped nearly 2 percent this year. It is on track to close out with a weekly loss for the 11th time this year.

Like Morganlander, Mark Newton, technical analyst at Newton Advisors, also sees high yield's losses this year more as a product of rising rates than a larger concern.

"A lot of that underperformance has just come from interest rates alone, so, yes, there has been divergence. My thinking is it's not that problematic at this time," Newton said on "Trading Nation."

Widening credit spreads are also a reason for the divergence in the high-yield space and equities, according to Morganlander.

"You've had a modest widening out of spreads but nothing that's too alarming which would indicate to us at least an early-stage credit dislocation or any financial stress," Morganlander said.

One scenario would switch high yield's weakness from harmless to a warning sign, Morganlander said.

"If you get into a bumpy economic cycle, high yield typically correlates with stocks, and that is one thing to be concerned about," he said. "We're not there at that point in the economic cycle so we believe high yield at this point does have a place in investors' portfolios that are diversified."

Forecasts show no signs of bumpiness. The U.S. economy is expected to grow at a steady pace this year with changes to the tax code giving a boost to corporations and a healthy labor market keeping consumer confidence chugging along. Economists anticipate full-year GDP of 2.7 percent, 40 basis points above 2017, according to FactSet data.

While the HYG has fallen nearly 2 percent this year, the is down just 0.3 percent. High yield and stocks have historically been highly correlated.


Disclosure: Washington Crossing Advisors has a position in the HYG ETF.