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Sunday, September 16th, 2012
a great time for junk

While there has been a noticeable lift in long-term Treasury rates, that has not been the case in junk land, as you can see above.

The top panel shows the performance of those bonds, as measured by the CS High Yield Index II, along with that of the S&P 500.  In the middle is the yield to worst on that index and, at bottom, the spread to worst.

It’s easy to spot the stunning rise in rates during the financial crisis, when investors fled from weaker credits.  The nominal yield on the index is now at the low point since the start of the series, although the spread is not.

It has been a great time for junk.  Will it continue?  Certainly if we get into a weak economic environment, the bonds will get slammed, with yields and spreads rising and that total return line headed down in a hurry.

What’s harder to figure is what will happen if the economy picks up.  All rates would likely rise in that environment, but the junk spread may very well narrow.  There’s not a lot of interest rate risk in these bonds, so the damage should be minimal unless rates jump a lot.

“Investor risk” is the wild card.  In a better economic environment, stocks are likely to do well and the odds aren’t good that junk will keep up.  The money that has flooded in will start to trickle out and if the performance gap persists, this overly-loved area could become the proverbial “source of funds” for a long time to come.  (Chart:  Bloomberg terminal.)

hot off the press

If you deal with long-term investment issues, check out The Prudent Fiduciary Digest.  The latest issue (#7) includes links to interesting reading on benchmarks, bad asset manager presentations, changing risk tolerance in response to market moves, and investment beliefs.