Here is a chart which shows the credit spread of high yield bonds vs. the default rate of high yield bonds since 1997.
In 17 out of 19 cases high yield bonds produced positive returns despite negative returns on Treasures and in 19 out of 19 cases high yield bonds outperformed Treasuries.
Does this mean that high yield bonds are over-valued? (likely), that Treasury bonds are over-valued, since high yield bonds are priced as a spread above Treasuries? (very likely), and that high quality stocks in a universe of mostly overvalued liquid assets are relatively cheap? (likely).
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Taking this distortion to yet another level, compared to high yield bonds, blue-chip, high quality stocks look incredibly cheap!
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In a world where Federal Reserve zero-interest-rate policy has made it impossible to earn any real yield the 10-year Treasury rate is well below 2% on standard-issue bonds, the income payout on high yield bonds (the polite term for junk) is proving too hard to resist.
The ugly junk bonds of old have now become the more palatable high yield bonds of today.
Asset allocation: What percentage of your total portfolio will you allocate to U.S. equities, international stocks, U.S. bonds, high-yield bonds, etc.
The new tax is even more reason to move income-generating investments such as high-yield bonds or high-turnover mutual funds into tax-sheltered accounts such as IRAs, says Eric Lewis, a principal at Bedrock Capital Management, a financial-planning firm in Los Altos, Calif.
As a final note, the historically narrow spread between high yield bonds and Triple-B corporates does not mean that the high yield asset class is materially overvalued.
Bonds, particularly high-yield bonds, and dividend stocks have become the go-go investments of the era.
However, history tells us that various bonds, say high-yield bonds, Treasuries or Investment Grade Corporates, tend to move together.
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During the same time frame high-yield bonds slumped 26% and bank loans fell 24%, while 5-year Treasuries gained 16%, according to our research (municipal bonds, another high-quality fixed income asset class, returned 9% over the same time span, as measured by the BarCap 5-year Municipal Bond Index).
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Why are emerging market high yielding bonds doing worse than low yielding U.S. Treasurys?
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Alternative scenarios are especially pertinent in evaluating the current outlook for high yield bonds.
Yet, emerging market and high yield bonds in general have underperformed safety all year.
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The 9.25% high coupon bonds due 2019 went from 134 to 126.78 in price.
If credit conditions deteriorated, active investors could move to very high quality bonds, including Treasurys.
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This suggests that stocks may be attractive investment opportunities versus even high yield bonds.
High yield bonds work to pick up the slack created by anemic Treasury returns.
High yield bonds and senior floating rate loans have performed quite well over the past four years.
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Even when the details of credit default swaps and high yield bonds lead to fits of sudden-onset narcolepsy!
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In short, the yield on high yield bonds is not low because investors are inadequately compensated for risk.
So entertain, then buy some of the few high coupon bonds left that have yet to be called.
High yield bonds, plus 1 percent, seem on track to earn their coupon (6 percent) but little more.
Additionally, many mutual funds have been forced to sell their high quality, high yield bonds because of redemptions.
There are attractive opportunities in both high yield loans and high yield bonds and the details really do matter.
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Areas to avoid include longer-term sovereign and municipal credit and high yield bonds.
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The financing window for high yield bonds, even CCC credits, is wide open.
In fact, the rate of return you can earn today on high yield bonds (6.61%) is the lowest absolute yield on record.
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See: U.S. Treasurys Killing High Yield Bonds, But Are TSYs Sustainable?
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