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Too Much JNK in the Trunk?

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By David Gillie

NEW YORK (ETF Digest) -- In a volatile and uncertain market, yield hungry investors have piled into every means of bonds to find return on their capital. With interest rates at historic lows, this hasn't been an easy task to find yield. Treasuries are at negative yield. A municipal bond failure scare rippled through the market on a well-known analyst's prediction. The chances of Greek and European default beckoned only the highest risk investors and that risk was magnified by the recent failure of MF Global.

High Yield Corporate Bonds became the place to find yield--often referred to as "Junk Bonds" and made famous by Michael Milken in the 1980's. However, 98 charges of racketeering and securities fraud against Milken and a 10 year prison sentence (reduced to two years) put a black stain on the so-called junk bonds.

Time passed and the junk bond scandal was forgotten. The fact is, that high yield corporate bonds rarely fail. The Buy and Hold King, John Bogle and creator of the low cost index fund at Vanguard Investments, drew huge numbers of the most conservative investors into high yield corporate bonds in mutual funds for decades as a steady and reliable stream of income.

Now enter the explosion of ETFs into the market. It was a natural that the ETF industry would create High Yield Corporate Bonds to mirror the highly desirable corresponding mutual funds. Unlike mutual funds that are settled at the end of the day and have a 90 round trip rule, ETFs--often identical in their composition to corresponding mutual funds--can be traded intraday and have no round trip rules.

ETF bond funds took on a completely different role from their elder brother of mutual funds. By their nature of fast trading, stop setting, repurchasing, they are often used as hedges in a portfolio for short term holding. Additionally, most have options available (unlike mutual funds). ETF bond funds are now often bought as equity funds for their capital gain and the dividend is just icing on the cake. Again, which is a contrast to mutual funds, where yield expects to exceed capital gain.

SPDR Capital High Yield Bond (JNK) is among the most highly traded of the industry.




With nearly 7-1/2% yield, even at the highest price, it's no wonder investors have bought this ETF in droves. Add to that over 3% capital gain in a month - more than most mutual fund bond holdings would expect to gain in a year. But as it has been bought in near panic mode, it can also be sold in the same fashion. A sell off, can obliterate the 7% yield and have a loss of capital investment.

As you can see on the chart below, JNK dropped 17% from nearly $41 to $34 from May to October. Bye-bye yield AND investment.

The two indicators at the top of the chart, Money Flow Index and Relative Strength Index, tell an interesting story together. The RSI is at its most overbought level, and yet the MFI is not at equal levels. This indicates waning interest for buyers to pay higher prices.

In the short term, price appears to have made a breakout above resistance with volume. However, a selling spike on Thursday significantly exceeded buying level volume. Furthermore, long term resistance from the May highs of $41 isn't far away. In fact, the previous $41 high dates back to pre-crash August '08.

Prudence and caution are the hallmark of the wise that have a position in JNK or are expecting to. There's hardly anything more agonizing than leaving a profit on the table and seeing it melt away.

The good news is there is pretty good support around $38. If you are seeing yield, it will, of course, be even higher at this level. JNK is one of the few places that yield seekers can enjoy significant capital gains as well. But, you have to watch it closely for opportunities to take profits and re-enter. JNK may currently be reaching a pivot point.

Disclosure: I currently have no position in JNK.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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