Junk bonds are not so junky now. ICE Bank of America's High-Yield index reveals that this sector has been yielding 3.97 per cent lately. The yield in March 2020 was at 9.2 per cent. It was when the COVID-19 pandemic and lockdown hit the country. It was the first time the collective junk yield was lower than the inflation rate.
Junk Bond Yield Falling. Is it a Concern?
Charles Schwab's fixed income strategist Collin Martin said that the corporations have managed in weathering the storm of the COVID-19 pandemic and have positioned well. They have accumulated cash, and the significant advantage was the low-interest record rates. The lower-quality companies found the Fed kept the interest rates low, which turned advantageous to them.
Rising Issuance and Underwhelming Returns
The total high-yield debt issuance in 2021 was $298.7 billion, and the figure was more than 51.1 per cent from the same point in the previous year in which a record-smashing $421.4 billion was witnessed in junk issuance. Simultaneously, the investment-grade issuance plunged 32.7 per cent in 2021.
Investors found the returns underwhelming. In 2021, the $9.3 billion SPDR Bloomberg Barclays High Yield Bond ETF was the least positive. It carried a yield of 4.21 per cent. It witnessed outflows of $3.34 billion even though it is true that investors usually avoid ETF's that trade in the high-yield market. Institutional and mutual fund investors were willing to take risks and witness some yield.
The investment world has become challenging as fundamentals are good and the valuations are awful. Fundamentals win out, and investors are cautious about high yield. Risk-reward is currently skewed; hence investors need to be realistic. Going the other way is not on the cards right now or anytime soon.
Experts suggest protecting the investment by moving up the quality ladder instead of risking it.
It is time to look for rising stars, to invest in companies moving up in credit quality. Such companies include Murphy Oil, Booz Allen Hamilton and First Energy. The fallen angels are Delta Air Lines, General Motors and Darden Restaurants.
Wall Street expects more companies to move up the quality scale in 2022. 2020 witnessed a near-record number of fallen angels.
Inflation and Ill Effects
Inflation spoils the high yield. The 13-year high of CPI in June 2021 is a good signal that the inflationary pressures are hovering over the market, and the threat could push up interest rates. It is to understand here that the yields and prices move opposite each other. High yields in the bond market may eat the capital price appreciation for the bondholders.
However, the Federal Reserve is on the sideline until the employment objectives are not met, but a tighter central bank threat always looms over the bond market. The Fed tightening, in fact, kills a credit rally.
COVID-19 Pandemic and Financial Market
The impact of the COVID-19 pandemic was severe in the financial markets, including bonds. The United States and Europe were in virtual lockdown. The DJIA and NASDAQ Composite closed down 10 per cent and 9.4 per cent, respectively, on March 12. On the same day, the European stock markets were down by 11 per cent.
The stock market crashed at the beginning of March 2020, and simultaneously, the bond prices moved in a similar direction, though unexpected as bonds are always considered a safer investment. The Chinese corporate bond defaults dropped 30 per cent, and the interest rate in China fell to a 14-year low.
Moody's downgraded its outlook on the US corporate to negative on March 30, and the study was based on global air travel, cruise ships, lodging, oil and gas, banking and automobiles.
Bubble Trouble for Junk Bonds Verdict
The bond market is considered a safe investment compared to the stock market. When the stock market moves down, investors shift the investment from stocks to bonds. But the COVID-19 pandemic phase was different as rates of interest were lowered by the Fed.