When the Fed started Quantitative Easing in an effort to jump-start the economy by driving down interest rates they also forced the hands of income investors. With 10-year treasuries at less than 3%, CD’s at 1%, investors moved to High Yield Bonds (aka junk bonds). Over the last three years ending 16 June 2014 they outperformed the returns of all bond competitors with a 30.74% total return compared to US Aggregate Index at 10.22% and US Corporate Index at 18.12%.
As of June 30, 2014 the High Yield Index (HYG) stands at less than $1.00 from its post crash high of $95.96 set in April 2013. High yield issuance is up 5% this year as companies rush to issue bonds. The average bond is trading at 105, the highest average price at the May 2013 market high was 107, so, we are very close to another top. There is very little news left that has not been accounted for, to push these prices much higher. With the space now very crowded, one of three outcomes seems to be the most likely. 1) The economy improves and rates start back to more normal levels hurting all bond prices or 2) the economy falters due to one of a million possible negative impacts, which will hurt high yield prices due to an expectation of a rising default rate. Currently high yield default rates are at a historically very low level and 3) the third possibility exists that the economy continues to slug along at a very weak pace and nothing happens for a while and high yield bonds will pay out the coupon rate of approximately 5.75% with not much gain from bond price appreciation.
Yes, we are talking about a top or a bubble for high yield bond prices and you know that usually doesn’t end very well. That being said, everyone needs to review your high yield bond positions and have a strategy to follow when the change happens. It will happen, no one knows when, but history tells us it is very close.
Talk to your advisor to develop your best course of action.
David E Siegel
Certified Estate Planner
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Quantitative Easing (QE) is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market.
Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio as the principal is adjusted semiannually for inflation based on the Consumer Price Index – while providing a real rate of return guaranteed by the U.S. Government.
CD’s are FDIC Insured and offer a fixed rate of return if held to maturity.
High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.
Investing involves risks, including possible loss of principal. No investment strategy assures a profit or protects against a loss.
High yield index is a rules based index consisting of liquid US dollar-denominated, high yield corporate bonds for sale in the United States, as determined by the Index Provider. The Index is designed to provide a broad representation of the US dollar-denominated high yield corporate bond market. There is no limit to the number of issues in the Index.
The Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.
The Barclays Capital U.S. Corporate Index covers the universe of investment-grade rated corporate bonds issued by U.S. companies or specified foreign entities or corporations. Bonds must be U.S. dollar denominated, SEC registered, rated at Baa3/BBB- or better by at least two of the three major rating agencies (Moody’s, S&P, Fitch) and have at least one-year remaining to maturity and at least $250 million outstanding. Convertible and floating rate bonds are not included.
David Siegel is a registered representative with, and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Strategic Wealth Advisors Group (SWAG), a registered investment advisor and separate entity from LPL Financial.