There’s a Reason They Call it Junk: High-Yield Bonds Yielding Less, Risks Remain
While all eyes have been on Ben Bernanke’s vanishing yield trick for Treasuries, high yield corporate bonds have also seen a sharp decline in yields this year.
Historically investors have demanded a yield on so-called junk of at least 7% to compensate for the added risk of lower-rated debt. But the recent breach of 7% isn’t by just a few mere basis points, it’s now closer to 6% than 7%.
But as Anthony Valeri, market strategist at LPL Financial pointed out in a recent note, the spread between junk and Treasuries is still pretty solid. “The average [junk to Treasury] yield spread remains above early 2011 levels and still notably above pre-crisis levels. While the record low yield urges caution, moderate valuations suggest high-yield bonds may continue to draw demand.”
That said, don’t be banking on a repeat of 2012’s sweet performance. As yields fall, bond prices rise; for total return investors (price change + reinvested income) junk has nearly kept pace with a very strong 2012 stock market. Take a look at the SPDR Barclays High Yield ETF (JNK) compared to both the SPDR S&P 500 ETF (SPY) and the high-quality bond index fund run by Vanguard (BND).
Today’s lower junk yields leaves less room for rates to fall further. And just as a friendly reminder, if we do hit any economic turbulence (fiscal cliff, stalled economy perchance?) junk bonds will get hammered on the way down. Here’s the 2008 carnage.
There’s a reason they call it junk.