High yield bonds returned a robust 15.4% in the year ending June 30, extending a winning streak that produced a 56.4% cumulative return since the end of 2015. After a quick, severe drawdown at the height of the COVID-19 scare, junk bonds have experienced nearly ideal market conditions, heralding a return to trends that have been in place for several years. The post-pandemic move toward this record low has been a boon to high yield bond investors, but it has also created a significant risk of reversal. We believe most things in the financial markets are defined by cycles, with Treasury yields and credit spreads no exception. Tight readings for both rate series demand that we consider the possibility that a cyclical reversal could weigh on junk bond prices going forward.
High yield corporate bonds returned over +15% for the twelve months ended June 30th, building on a strong five-year run that was interrupted by a short, but painful, drop at the onset of COVID-19. Chart 1 indicates that high yield bonds compound at a remarkably steady rate, with infrequent but severe drawdowns during times of financial stress.
Net outflows continued as the cushion from credit spreads is still inadequate...So far risk contagion from the Puerto Rican bond default has not been an issue. Munis still look attractive relative to Treasuries, and investment grade Corporates...The improvement in credit markets and inflation expectations looks more shaky as oil prices broke below the recent tight range and uncertainty around Greece adds to the overall risk aversion. We reduced these bonds to Unfavorable.
High yield bonds are not immune to the tapering of QE.
Merrill Lynch was first but the rush is on, stripping existing T-Bonds of their coupons, repackaging and selling coupons and principal separately. While perhaps priced too high for sharp pencil pushers, to us they look like a very good investment. Corporate “zeros” should, however, be viewed very cautiously.