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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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.
The ugly junk bonds of old have now become the more palatable high yield bonds of today.
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.
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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Taking this distortion to yet another level, compared to high yield bonds, blue-chip, high quality stocks look incredibly cheap!
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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?
Here is a chart which shows the credit spread of high yield bonds vs. the default rate of high yield bonds since 1997.
In any case, if Treasury rates rise substantially from their present level, history strongly suggests that high yield bonds will be comparatively well cushioned.
Investors require compensation for the risk that market conditions will be unfavorable at a time when they need to sell their high yield bonds.
My cost of carry on high yield bonds runs at 70 basis points for a net yield to maturity for me near 6 percent.
The conclusion seems to be that investors are not being paid well at present to take the incremental risk of high yield bonds over Treasuries.
Just as in the past, high yield bonds trade at an interest rate spread over Treasury bonds, which are more liquid and less subject to default risk.
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.
The credit spread simply measures how much more high yield bonds yield than treasuries of similar maturities (read more on the basics of credit spreads here).
But as the Fed has driven interest rates on Treasuries below the inflation rate, retirees have sought higher returns in riskier investments, such as high yield bonds.
In short, by historical standards high yield bonds are currently offering only a modest yield pickup versus better-rated bonds, rather than relative to emerging markets bonds in particular.
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.
If I believed this to be an accurate analysis, I would be tempted to move every dollar I have into high yield bonds and borrow on a home equity line to buy even more.
By contrast, high yield bonds were yielding 6.61%.
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