Junk Bonds: Signal to Buy or Sell?

Trying to find a sign in the high-yield bonds hiccup? Perhaps it is nothing more than investors growing worried about valuations after big profits.

Popular junk-bond exchange-traded funds ended Wednesday in their lowest levels since March. While declines are minor, only 2.6% since last month’s high, the question is if credit-market weakness could presage a stock-market slide.

Both don’t need to coincide, though, and investors frequently pare back junk holdings without ditching stocks en masse. This was the case in March, June, and July when high-yield declines failed to stress the stock exchange.

Ultra-low rates of interest in the wake of the financial crisis allowed U.S. companies to issue debt on favorable terms. Prices rose, and the payout investors receive from owning speculative-grade bonds over Treasurys, or “spread,” last month dropped to the lowest in a decade.

Now, fully 60% of high-yield investors say junk-bond spreads show that the market is overvalued, based on November’s credit investor survey from Bank of America Merrill Lynch. Some 52% of junk-bond investors anticipate wider spreads annually from now.

With junk bonds appearing expensive, Jim McDonald, chief investment strategist at Northern Trust, which manages over $1 trillion, announced this week that his company pared back high-yield bonds.

However, his shop is sticking by U.S. and global stocks for reasons that are well understood: The market is growing, though not quickly enough to warrant the type of sudden central bank tightening that would give the equity market pause.

He says nothing has changed in recent weeks to undercut the big-picture case for owning junk bonds and recommends buying the dip.

Mr. Slok claims that a sustained widening in high-yield credit spreads isn’t likely until central bankers in Europe and the U.S. take extra steps to tighten monetary policy at the same time, possibly beginning in the middle of next year. Until then, he says, the song remains the same.

source https://capitalisthq.com/junk-bonds-signal-to-buy-or-sell/