Are junk bonds trash or treasure these days ? that is loaded with facts useful for the DIY investor. Junk bonds, or as they are more politely called, high yield bonds, represent at least a small portion of most DIY investors' portfolios via exchange traded funds like HYG or JNK.
Here are some of the facts that I garnered from the article:
- junk bonds yield between 7% and 8% versus 1.62% on the 10-year Treasury note (actually the 10-year T yield has since moved up to 1.80%)
- over the past 15 years, the average junk bond fund has gained 5.18%/year versus 4.72% for average large blend stock funds (think S&P 500 comprised of value stocks and growth stocks)
- high rated corporate bond funds gained an average of 5.77% over past 15 years
- long-term government bond funds have trounced junk and corporate bond funds, up an average of 9%/year
- worst 12 months for junk bond funds ended 11/2008, when average junk fund was down -30.1%
- other 12-month losses were 2000-2002 bear market and 1990 - 1991 recession
- today, according to Moody's, junk bonds yield an average +6.83% to Treasuries and the average yield spread is +5.61%
- more companies had ratings upgraded than downgraded in the 1st quarter
- current default rate = 3.1% versus 1.9% in December
- Moody's estimates the default rate will peak at 4% in October and fall to 3% in May
- Worst case is greater than 10% default rate in 5/2013.
The first obvious take-away is that Waggoner's articles are flush with useful information. Secondly, junk bonds are fairly attractive on a yield spread basis and on an expected default rate basis. Other things equal, a yield spread of +6.83% overcomes 4% default rate. Thirdly, this sector gets pounded in an economic downturn. Thus, if you are expecting the economy to weaken, lessen exposure. If the yield spread to Treasuries gets to less than +5.61%, again think of lightening up a bit - this is the point where you start to not being paid to take the risk. A final point to note is that, when investors get scared, nothing beats Treasuries, as shown by the performance numbers Waggoner reports.