Last Friday Barclays PLC index of Junk bonds fell below 6%. That is less than Treasuries were yielding 20 years ago.
It has been a wild five year ride for less than investment grade debt.
In 2007, before the collapse of the housing market, they were trading at a yield of a little more than 7.5%. In less than two years the index had risen to a jaw dropping rate of more than 22%! The slide down has been no less spectacular.
Since mid 2008 the yields have fallen at the spectacular rate at which these rose. The result has been one of the best returns for investors over the past five years, averaging better than 10% a year at a time when treasuries yielded less than 2%. Never in history has there been such a discrepancy between “safe” investments and junk.
Junk bonds are now priced to deliver yield most pundits believe will be substantially lower than the past 5 years, in fact more like US treasuries were yielding less than 25 years ago, around 7%.
All markets reach a point where there is no more upside based on the current price. One of the keys to that is the volume that is being generated. In the case of Junk bonds you have to look at the number of bonds that are trading above “par”, in other words the companies issuing the bonds can “call” them in to fund at lower prices.
Last year companies bought back a record $101 billion of their existing debt at rates averaging much less than 5%, with the vast majority of bonds trading at a premium to their coupon you can be sure that this trend will continue.
At 22% yield, the common wisdom was the less than investment grade bonds were too big a risk for most investors. If that is the case, how do you justify buying them at less than 6%?
I agree this run is probably over.
Keep those stops tight.
Todd “Bubba” Horwitz