High-yield bonds are different from other bonds like Treasuries and investment-grade corporate bonds. In the bond family, high-yield bonds act differently.
These bonds are much more like equities than bonds. When investors are in a risk-taking mood, they reduce exposure to safer investments like bonds and invest in equities. When high-grade bonds are seeing their prices fall and yields rise, high-yield bonds, for the most part, behave like equities. They see a rise in demand, a rise in prices, and a decline in yields.
Investors in these bonds shouldn’t take comfort. Due to risk-off sentiment, investors are piling up on bonds because high-yield bonds are more akin to equities.
Relationship with equities
The above graph shows the high correlation between equities, as represented by the S&P 500 index, and high-yield bonds, as represented by Bank of America Merrill Lynch US High Yield Effective Yield. The reaction time is also similar. This is unlike the case we explored in the previous part where Treasuries seemed to be leading equities in the same ten-year period as examined here.
High-yield bond issuers Zayo Group Holdings (ZAYO), HD Supply Holdings (HDS), and Community Health Systems (CYH) have been cautious about raising debt this year. Until the week to April 18, the issuance of high-yield bonds fell 54% compared to a year ago, according to S&P Capital IQ LCD. There were uncertainties until the end of March. By the end of 1Q16, the issuance fell by 73%—compared to the same period last year.
In the next part, let’s see why fixed income markets are rallying.