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.

US High Yield B Effective Yield Chart

US High Yield B Effective Yield data by YCharts

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.”

US High Yield B Effective Yield Chart

US High Yield B Effective Yield data by YCharts

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).

JNK Total Return Price Chart

JNK Total Return Price data by YCharts

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.

JNK Total Return Price Chart

JNK Total Return Price data by YCharts

There’s a reason they call it junk.

Carla Fried is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

Read more articles about: Investing Ideas  

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