One of the less frequently discussed consequences of the significant financial market upheaval since the end of March is identifying potential losers beyond the investors themselves.
There will likely be casualties among traders who are compelled to sell securities to meet margin calls. These traders had invested heavily in risky stocks or high-yield bonds, whose values declined when the stock market dipped.
The value of a bond consists of the present value of its regular coupon payments, typically paid biannually, and its principal value. When interest rates increase, both the income stream’s value and the underlying bond’s value must decrease.
When investments have been built heavily on borrowed funds, traders may be forced to sell assets to fulfill their obligations. In such cases, investors often begin by selling their most valuable holdings, as explained by Jeffrey Gundlach, CEO and Chief Investment Officer of DoubleLine Capital, during an interview with CNBC. Gundlach started observing forced selling when the Dow Jones Industrial Average fell by 5.5% and the Standard & Poor’s 500 Index nearly 6%.
On the following Monday, forced selling became even more apparent amidst volatile stock prices. Bond yields rose, which further reduced the market value of the bonds. Gundlach believes that the selling pressure may continue, forecasting that the S&P 500 might bottom at 4,500 but also suggesting the potential for bankruptcies, despite having no specific knowledge of companies in distress.
In an unexpected turn, the stock market recovered from morning lows, with the S&P 500 dropping to an intraday low of 4,835.04. This decline brought the relative strength index (RSI) for the S&P to 19, indicating an oversold condition, typically considered a “buy” signal. Consequently, futures trading pointed to a substantial relief rally expected on Tuesday.
Viewers looking to understand the data further must note that many bonds are not traded on organized exchanges, complicating visibility. For instance, the SPDR Bloomberg High Yield Bond exchange-traded fund (JNK) fell 0.9% to $91.61 on Monday, marking a 5.7% decline since its February 28 level of $97.12. This ETF, almost entirely invested in bonds rated BB or lower, experiences price fluctuations when interest rates rise or when energy prices fall due to its composition, including bonds from the volatile energy sector. However, it boasts a distribution yield of 6.94%, offering some reassurance for investors.
