US junk bond frenzy will end in tears
Aug 28, 2012
In a world of “incredibly low interest rates”, the hunt for yield “has become a maniacal pursuit”, says Alan Abelson in Barron’s. That explains why investors have been piling into junk bonds – risky corporate debt that offers high yields to compensate for the danger of default. But investors should beware of jumping on the bandwagon, especially in America.
A “feeding frenzy” has developed in the American high-yield market, says Bonnie Baha of DoubleLine Capital LP. Junk bond yields, as measured by the Barclays high-yield index, have fallen to near-record lows of under 7% as prices have risen. But history shows that a typical junk bond yield is above 10%.
“It’s amazing,” says Adam B. Cohen of Covenant Review. In recent weeks, some firms have issued speculative-grade debt at very low yields. Some weak companies are now offering yields of around 5%, the kind of figure blue chips such as Exxon or Pepsi used to offer, says Peter Lattman in The New York Times. What’s more, as Abelson points out, around $43bn has been poured into US junk bond funds this year, which is 130% higher than the existing full-year record.
This is “not a sustainable state of affairs”, as Bank of America Merrill Lynch puts it, especially as the economic backdrop is anything but encouraging. Investors are ignoring the threat of rising default rates amid a slowing global economy. They would be far better off with defensive equities, which offer high yields and should prove resilient in tough times.
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.