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The End Is Near, Part 2: Everyone Piles Into Junk Bonds

Six years into a recovery, stocks at record levels, high-end real estate in the stratosphere and debt levels soaring in virtually every public and private sector. Time to scale back and protect those gains, right? Wrong, apparently, for a depressingly obvious reason: Huge sections of the investing public can’t afford to move into cash or even into conservative paper like short-term Treasuries.

Pension funds that are required to generate 8% annual returns, insurance companies that only make money if incoming premiums earn at leas 6%, retirees who need to generate cash on their savings in order to eat, mutual funds that are judged on quarterly returns, hedge funds that have underperformed lately and will see a tidal wave of redemptions if they don’t outperform from here on out — all feel compelled to make even more money this year than last. They therefore have no choice but to roll the dice for big immediate gains. And guess what they’re choosing:

Junk bonds take the lead in fixed-income returns

After plunging oil prices sent the U.S. high-yield corporate bond market into a tailspin late last year, the asset class has come back.

High-yield is the best performer in U.S. fixed-income in the year so far, after chalking up positive returns in April to outperform investment-grade and Treasuries.

High-yield debt has returned 3.8% in the year so far, according to the Bank of America Merrill Lynch Global Index System. That compares with 1.7% for investment grade and 1.3% for Treasuries.

The asset class has also outperformed the broader stock market, with the S&P 500 SPX, +0.92% showing total returns of 1.1% in the year so far, according to FactSet data.

“There’s just been a desperate demand for yield because rates are so low,” said Martin Fridson, chief investment officer of wealth management firm Lehmann Livian Fridson Advisors. “Fears of a rate hike have receded and the expectations have been pushed back to 2016, and high yield has benefited.”

In April, the high-yield sector had a positive total return of 1.2%, while investment grade had a negative return of 0.5% and Treasuries a negative return of 0.4%. As of Thursday, high-yield was offering an extra 459 basis point-spread over Treasuries, according to Bank of America Merrill Lynch.

Not surprisingly, high-yield issuance has continued at a healthy clip. U.S. issuers have sold $133.8 billion of debt in 176 deals in the year so far, according to Dealogic. That’s up from $126.5 billion in 212 deals in the same period in 2014.

What’s depressing about this is the repetition. Since the late 1980s, panicked governments have responded to slowdowns by herding their most vulnerable savers into excessively risky assets and then pulling away the football. And every time the same groups fall for it. Supposedly risk-averse capital flows to the least appropriate borrowers, who satisfy the demand by issuing a tidal wave of crappy paper which blows up in short order.

And then the game begins again. Since this process is so obviously purposeful and clearly doesn’t help the individuals who have their nest eggs and pensions depleted by the inevitable busts, the only conclusion is that someone else is getting something out of it. Wonder who that could be?

6 thoughts on "The End Is Near, Part 2: Everyone Piles Into Junk Bonds"

  1. Always go to land when the boat begins to leak. Owning property is the best bet. It’s not going any where and people always need a place to live. If property values go up or down it doesn’t mean a thing if you own it outright it won’t effect your income. If they can’t afford the rent I lower them. It’s the people who are greedy who buy property with leveraged money that jack up the rents on working class people that are really rotten apples in the world.

  2. Kind of like the expression: “When pigs fly.” And the porkiest debt in the world is catching the best bids right now, but memo to junk bond buyers: Indications are very solid right now that the world and U.S. economies have entered another downturn. Guess what debt coughs up the giant hairball first in a business retraction: JUNK. Where do you think the name came from? Not from Tiffany’s! Thank the Federal Reserve for giving you no yield on your bank deposits and CD’s, such that you must chase yield. CAN WE PULL THE CENTRAL BANKERS’ PENSION AND HEALTHCARE BENEFITS?????????????

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