VTI - September CPI A Touch Hot High Yield Bonds Suggest Caution

2023-10-12 09:35:37 ET

Summary

• September CPI rose 0.4% MoM, slightly higher than expected.
• Core CPI rose 0.3% MoM, in line with estimates.
• Expectations for a Fed rate hike in November are now under 5%.

The September CPI report revealed a hotter-than-expected 0.4% rise in monthly consumer prices compared to the +0.3% consensus. The Core rate rose 0.3% last month, matching estimates. The year-on-year headline rate was unchanged at +3.7%, one-tenth to the warm side versus expectations while Core CPI rose 4.1% from a year ago, in-line with estimates, and the softest rate since September 2021.

CPI has now risen for four straight months as energy prices have inched back up, but the recent decline in both WTI (CL1:COM) and wholesale gasoline prices could help the inflation story over the coming months. Expectations for a Fed rate hike in November are now under 5% while a December hike also appears unlikely (about a 1-in-3 chance) as CPI prints a 3-handle on an annual basis.

A rise in gasoline prices certainly pressured the headline rate while apparel and used cars were detractors from inflation last month. Shelter was, of course, a large contributor to the rise in CPI, but housing costs are seen as a very lagging indicator. Just this morning, we received high-frequency data from Redfin indicating somewhat softening home prices nationwide. Overall, transportation costs rose 9.1% from year-ago levels while shelter costs jumped 7.2%.

On the wage front, U.S. real hourly earnings are now higher by 0.5% on an annual basis while jobless claims came in close to expectations in data released at the bottom of the hour.

September CPI Verifies to the Strong Side Modestly

Headline CPI Rises 0.4% MoM, +0.3% Core

Headline CPI YoY Turns Higher From the Summer Lows

CPI Components

Fed Funds Futures Suggest Lower Rates Ahead Compared To Last Week

A November Hike Just About Off the Table

In terms of market reaction, equity futures dropped modestly, but were still in the black, given the higher-than-expected inflation print while the US Dollar Index remained in the red, pacing for its lowest close since September 25 and a second straight month of losses.

Following today’s almost in-line CPI report, there remains a focus on the domestic bond market. Treasury yields have come off their highs, but we have seen a slight uptick in the speculative-grade fixed-income market. I like the graph below from WisdomTree to get a sense of bond fund options. You will see that high yield features a lofty yield to worst and a lower duration compared to other parts of the corporate credit market.

I reiterate my hold rating on the SPDR® Portfolio High Yield Bond ETF (SPHY) as a higher yield today is offset by a concerning chart.

High Yield Bonds Now Yield Above 9%, Shorter Duration Versus IG

High Yield Credit Spreads Tick Up, Remain Modest

SPHY is a low-cost fund to access the speculative credit market. According to the issuer , SPHY seeks investment results that correspond to the price and yield performance of the ICE BofA US High Yield Index.

SPHY is a large fund with more than $1.9 billion in assets under management and it features a modest annual expense ratio of just 0.05%. Liquidity is strong with the fund given average daily volume of slightly more than one million shares and a 30-day median bid/ask spread of only four basis points. Momentum has turned weak, which I will detail later. With a current yield to maturity of 9.32% as of October 11, 2023, the fund is priced to yield the highest rate in many years (not counting the spike during COVID).

SPHY also features a lower duration compared to the aggregate bond index and investment-grade credit. So, it could be an ETF to consider for investors who believe corporate balance sheets are healthy enough, particularly among smaller and riskier companies, and if you believe higher rates will be the bigger story compared to an increase in defaults. The diversified allocation is most exposed to the Consumer Discretionary sector at 22% while Communication Services is next highest at just under 15%. Many investors think Energy is a big part of the junk bond market, but it is just 11.3% of SPHY.

I assert that the current yield is somewhat attractive given the equity risk premium for the S&P 500. Of course, it may be better to compare valuations on US small and mid-cap stocks to the SPHY. Also, I ran the numbers and found that domestic high-yield fixed-income has returned about 5.5% over the last 36 years while the average yield to maturity has been near 8.8%, so the YTM or yield-to-worst on SPHY must take into account some defaults.

High Yield Bond Performance Since 1987

SPHY Portfolio

The Technical Take

With SPHY’s yield creeping higher, above 9%, while junk bond spreads remain modest, there are concerns on the chart. Notice in the graph below that the fund broke down from a pattern I described back in Q2. The symmetrical triangle, or wedge, formation was a battleground between the bulls and bears, but a breakdown in September suggests that the bears won.

Take a look at the long-term 200-day moving average – it's now beginning to turn lower after moving sideways since June. Additionally, the RSI momentum indicator at the top of the chart has broken down into bearish territory. An oversold bounce appears to be ongoing, but with a high amount of volume by price in the $22 to $23 area, rally attempts will be tough for the bulls.

Overall, the chart has turned bearish, so a cautionary stance technically is warranted on SPHY.

SPHY: Bearish Breakdown From Consolidation

The Bottom Line

I expect traders to quickly look beyond today's CPI report, and I reiterate my hold rating on SPHY. Its YTM and YTW have risen to higher levels as the equity risk premium on equities holds near 20-year lows. While comparatively attractive, SPHY’s technical situation is concerning.

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