High yield bonds have come under pressure lately, and as a result, are now looking relatively attractive. Spreads recently widened out to the highest level in a year, indicating that high yield now offers better value and yield. In short, given that corporate America remains strong and default rates low, high yield now looks likely to provide a reasonable level of income relative to the rest of the fixed income market.
Market Realist – The graph above shows how the spreads between high yield bonds (HYG)(JNK) and U.S. Treasuries (TLT) have been widening in 2014. Given improving financial conditions, this opens up an opportunity for investment in the high yield market segment.
Market Realist – The graph above shows the price performance of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) over the past three months. Prices have been falling on concerns of high volatility (VXX), rising geopolitical turmoil, and anxiety about the Fed’s normalization policy. We saw the biggest drop in high yield bond prices in three years on October 14, 2014. As per estimates by S&P Capital IQ, yields touched a high for the year at 6.3%, giving yields of 4.7% percentage points more than U.S. Treasuries.
As the growth outlook for the U.S. economy looks better, default rates are likely to remain contained to their currently low levels. This could make high yield bonds an attractively priced investment opportunity. However, investors need to be cautious of the fact that both U.S. equity (SPY) and bond markets (BND) are likely to remain volatile in the next few months. Moreover, high yield bonds could be at risk as the cycle of interest rates turns.
The current global economy is showing signs of a slow-down, but a recession seems less likely. In this current context, investors need to focus on relative valuation for opportunities.
Read our series 5 things for every investor’s to-do list as 201 draws to a close to see where you can find opportunities.