High yield corporate bond prices have traditionally traded in a lagged correlation with the equity market. Since June of 2014, US high yield bonds have sold off an average of about 10% to date, while the S&P 500 continued to rise. One of the two seems to be mis-pricing present financial risks. Time will reveal which is prescient.
Of course inspired by QE faith, buyers have been overpaying for high yield bonds (along with most assets) since 2011. So these higher risk bonds that have traditionally yielded greater than 8% (hence ‘high yield’) had been priced to yield an all time low of just over 5%, setting risk-blind holders up for a capital drubbing. The past year or so has so far taken about 2 years of the expected income off the capital value. In past bear markets, high yield bonds have fallen 25 to 50% in price before the sector is sufficiently revalued to attract sober investors. The 50% plunge during the 2007-09 bear market is shown in the below chart of the Barclay’s High Yield Bond ETF (JNK).
Junk bond ETFs are trading at their lowest levels since 2011. Should investors be worried? Larry McDonald of Societe Generale and Todd Gordon with TradingAnalysis.com discuss. Here is a direct video link.