High yield bonds undermining stock jockey optimism

High yield bond prices historically trade in tandem with equity prices. Both are risky bets on the underlying corporations and market sentiment, at a given point in time. Contrary to the ‘long always’ prophets, the higher the price, the riskier and less attractive investments are to buy.

The chart below shows data from the St Louis Federal Reserve on the level of US Hi Yield spreads since 1996 (with Cory’s annotation) (ie., the extra yield that lower quality corporate bonds are paying holders when compared with similar dated government treasuries.)
Hi yield spreads widening Dec 2014Relevant is the fact that high yield spreads have gapped more than 5% above US Treasury yields, 4 times (pink boxes) in the past 18 years:  the Long Term Capital meltdown in 1998, the dot bomb implosion 2000-2003, the Great Financial Crisis  2007-2009, and the realization of a renewed global slowdown in 2011.  This fourth event spurred terrified central banks to throw every drop of liquidity and assurance they could muster at capital markets.  And as shown above, it worked for a while, as bond yields drifted lower again from late 2011 to mid- 2014.  Since then however, the trend is not encouraging.

Today back at 4.87%, high yield debt spreads are once more moving toward the 5% threshold that has marked the last 4 stock market shocks, when the revelation of capital loss woke deluded participants from complacent slumber.

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