Time to buy high yield?

Not just yet.

The time to sell junk bonds was in June 2014, when junk bonds were yielding an average 4.83%, at least according to the Barclay’s Capital High-Yield Index. (Department of minor victories: Don’t say I didn’t warn you.)

junkCurrently, the index yields 8.72%, which is a pretty fancy payout, considering that the 10-year Treasury note yields 2.25%. Those high yields are inspired, in part, by the shocking meltdown of the Third Avenue Focused Credit Fund.  But high yield was in trouble well before that.

Before you reach for yield, consider a few things:

Junk bonds are long-term IOUs issued by companies with shaky credit ratings. Just like your deadbeat friend Ralph, these companies have to pay high interest on their debts because of their dubious credit histories. Yields rise in the junk-bond market because traders think that risks are rising.

Junk bonds, like stocks, typically fare best when the economy is punk but looking better. At least in theory, companies that issue junk bonds can grow their earnings enough to improve their balance sheets and be better able to handle their debt payments.

The economy is still subpar, and few are predicting it doing a happy dance in 2016. A sluggish economy is probably the best we can hope for. According to Moody’s Investor Services, corporate defaults are likely to continue rising next year, particularly in the energy patch.

Furthermore, while short-term interest rates are low, the Fed has embarked on a campaign to raise them. Rising short-term interest rates act as a brake on economic growth, particularly for smaller companies. You’ll note that most banks raised their prime lending rates about 20 seconds after the Fed announcement. That will increase interest expenses for vulnerable companies.

The all-time high in junk yields was 22.14% in 2008, during the height of the financial crisis. We’re a long way from that. But it might be a good idea to see if junk yields go a bit higher — and prices a bit lower — before wading back in.

 

 

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