In my opinion, investors have been stretching too far for income for yield and ignoring risk. While there are few bargains within fixed income, I continue to like those parts of the market that offer some relative value, including tax-exempt bonds and mortgage-backed securities. In addition, for more yield hungry investors, I’d advocate some exposure to U.S. high yield, but with a caveat. You can read more about my fixed income outlooks in my latest Investment Directions monthly market commentary.
Market Realist – For now, you should avoid high-yield bonds in the energy sector.
The yield for ten-year Treasuries is 2.1%. High-yield bonds are returning close to 7.5%. This means the spread is ~540 basis points—compared to slightly above 1,800 basis points during the crisis. Treasuries are considered to be very safe because they’re backed by the US government. That’s why they command a premium. It’s also why they trade at lower yields.
High-yield bonds usually do well when the economy is doing well. This is because credit markets improve and their cash flows are higher. As a result, the probability of high-yield bonds defaulting is less. The opposite happens when the economy is in a recession.
However, the current scenario demands some caution before buying high-yield bonds. Due to the sudden slump in crude oil (USO) prices, energy companies’ (XLE) cash flows are at risk. As a result, you should avoid high-yield bonds in the energy sector.
Read Market Realist’s The New Fixed Income World for more information on the fixed income sector.