Friday, December 23, 2011

Junk Bonds Looking Less Junky

Junk bonds get no respect. By their very name, these high-yield corporate bonds are the victims of slander every time they are mentioned.

The exchange-traded fund JNK, which tracks high-yield corporates, trades in bonds that are rated below investment grade: At or below what Moody's calls Ba1 and both and Standard & Poor's call BB+.

Which sounded a bit scary when I first looked at JNK, until I realized that those rating levels are far from the bottom of the barrel.

And many of the specific companies in the JNK portfolio (as of last December) are either household names or make products that people regularly use in their lives.

Such as: Short-hop aircraft made by the Canadian company Bombadier, auto navigation systems by Navistar, airlines such as Continental and Delta, hard drives by Seagate, tires by Goodyear, chickens by Tyson, and rental cars by Avis.

So if those companies be junk, then junk is very much in the eye of the beholder.

The attraction of junk bonds, of course, is the higher dividends than are available from government paper. JNK's annual yield is presently 7.8%, and the fund pays out monthly, giving the trader lots of flexibility to trade in and out to avoid capital losses.

And capital losses there can be, since JNK tends to mirror business expecations more than the hopes and fears of finance.

Fortunately, JNK carries with it a good selection of options with fair liquidity, allowing the trader to hold on to JNK shares to collect the dividend while hedging against price declines by buying puts.

While the 30-year Treasury bond fund, TLT, has been falling sharply for four days, JNK has been rising steadily for eight trading days.

Why the divergence?

Well, there have been some good results from the economic indicators of late, suggesting  that business is picking up. Increased business activity eventually leads to inflation, which prompts the Federal Reserve allow interest rates to rise a bit, but that same activity increases the degree of certainty that companies will be able to pay off their debts.

JNK in its eight-day rise has been trading in an hourly-chart uptrending channel, within a broader daily-chart uptrend that began  Oct. 4. Both are within a downtrending weekly-chart channel that began last May.

A break above around $39.15 would be an escape from the weekly-chart downtrending channel, and trading above $39.70 would set a higher high. A trade above $40.93 would break above the high set in May.

The dividends are good, and wherever dividends are part of the mix, there's a tendency on the part of many traders to call it "long-term money" and to be reluctant to trade out in the event of a decline.

It helps me focus better when I realize that the average daily price range of JNK works out to about 0.9% of the price, so a decline of that magnitude can wipe out the annual dividend entirely in under nine days.

JNK might pay dividends, but it must be watched as closely as any other position, with appropriate stop/losses in place or with a defined plan to hedge with puts at stop/loss points.

I've added JNK to my portfolio in anticipation of the end of December payout.

No comments:

Post a Comment