There is no happier corner of the fixed income universe than junk bonds (JNK), (HYG), which have been soaring like a bat out of hell for the past four years. Average yields for the bond class most sensitive to the economy have collapsed from 18% to near an all-time low of 6%, a scant 400 basis points over ten year Treasury bonds.
The ETF (JNK), which I have been aggressively recommending since 2009, has clocked a three year total return of over 250%. In fact, junk bonds have outperformed stocks by a substantial margin since the great bull market began in March, 2009.
If you look at the chart for (JNK) it virtually tracks the S&P 500 one for one, with less volatility, and therein lies the problem. When bonds act like stocks, what happens to bonds when stocks go down? That is a particularly pertinent question these days as stocks have more than doubled in from the bottom, and are approaching grotesquely overbought levels. After a move in the S&P 500 Index’s average multiple from 9 to 15.5, with 16 a possible top, are junk bonds peaking out here?
A 400 basis point premium does not sound like much compared to the historical range. It is pricing in the near absence of risk in this paper, as if they will live forever? When did I last see this movie? 2006? 2007? How short memories have become.
It might be worth taking some money off the table here, and taking the hit in the cash flow in your portfolio. Lowering your beta is prudent, especially if you are about to move from a ‘RISK ON’ to a ‘RISK OFF’ world for more than a day. No doubt, much of the juice in (JNK)’s recent moves came from Ben Bernanke’s QE3. Do you really want to wait for the music to stop playing before you grab a chair?