High-yield bonds, or junk bonds, are rated below investment-grade—BB+ and below—according to the Standard & Poor’s ratings system. They have higher credit risk compared to investment-grade corporate bonds and Treasuries. Investors require higher yields to compensate them for the additional risk.
Exchange-traded funds (or ETFs)—like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the SPDR Barclays Capital High Yield Bond ETF (JNK), and the PowerShares Fundamental High Yield Corporate Bond ETF (PHB)—mainly invest in debt issued by high-yield corporate borrowers.
High-yield bond performance
The debt servicing ability of lower-rated borrowers depends on economic headwinds. When the economy is expanding, corporate revenues and profits increase. Corporate delinquencies usually fall and the high-yield debt issuers’ debt-coverage ratios improve. For this reason, stocks and junk bond returns usually move in the same direction.
Over the past few years, stocks (SPY) (DIA) and high-yield bonds benefited from the improving economy. Investment-grade bonds have also improved. The Fed kept monetary conditions accommodative in order to provide economic stimulus after the Great Recession.
Current economic conditions
Major stock indices—like the S&P 500 Index (SPY) and the Dow Jones Industrial Average (DIA)—have posted multiple record highs this year. However, high-yield bonds have undergone a few market corrections. The corrections were mainly due to external risk factors. You’ll read about the risk factors in the next parts in this series.
Last week, the Bureau of Economic Analysis (or BEA) released updated growth figures for the gross domestic product (or GDP). Real GDP grew 4.6% in 2Q14—an upwards revision from the 4.2% estimated earlier. In this weekly update, you’ll read about the factors that influenced junk bond returns.
You’ll also read about the issuance trends in the primary capital market for high-yield debt. We’ll discuss the current conditions in secondary markets. We’ll also analyze the impact of the GDP release and other key return drivers. We’ll cover high-yield bonds (Parts 2–5) and leveraged loans (Parts 6–7).
Visit the Market Realist High Yield Bond page to learn more.