Junk Bonds Today: Realistic Levels?

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 |  About: SPDR Barclays Capital High Yield Bond ETF (JNK)
by: Avi Morris

In the last six months high yield (junk) bonds have gone through the most violent period in their history. Last September the financial markets ran into a brick wall; stocks had a sharp sell-off, mirroring the collapse of the economy. Bond financing for companies and municipalities also collapsed. Junk bonds suffered the most.

Junk bonds had been riding out the bear market fairly well by pretty much holding their values. The Barclays Capital High Yield Bond ETF (NYSEARCA:JNK) sold off only modestly during the first eight months of last year, slipping to 42. Between September and November the ETF lost one-third of its value, taking it below 27 and pushing the yield over 16%. Individual junk bonds funds did much worse. Most plummeted, losing over half their value and forcing yields towards 25-30%. Stocks of junk bond funds rose sharply from the lows a few months prior. Those who bought at the lows have gains of 50+%, as the extraordinarily high yields on junk bond funds fell to the 15-20% range. Last week junk bond funds pulled back along with the stock markets, giving up a portion of recent gains.

Corporate bonds shared in the collapse of the financial markets, which prevented even top-tier companies from raising capital by selling bonds. Recently financial markets finally thawed a little, allowing Caterpillar (NYSE:CAT) and Cisco (NASDAQ:CSCO) to sell investment-grade bonds for corporate purposes. However the yields carried substantially higher premiums than in the past. Junk bond fund operations fared pretty well during these brutal times. These funds continue paying (the same) monthly dividends. One even had a substantial year end extra dividend. As the US economy continues to weaken, dark economic clouds may bring some rain (disappointment) on their future dividends.

Junk bonds trade as stocks with extraordinarily high yields, especially now. In 2009, junk bond funds rebounded from their lows while the Dow suffered a steep decline. Other high yield securities fared differently. MLPs, coming off very depressed levels, are up sharply in in 2009 while REITs are sliding, exceeding the decline of the Dow.

Hopefully future dividends (excess investment income after expenses) on junk bond funds will not be damaged badly in what looks looks to be an ugly year for dividends. Dividends for ordinary companies, even the very best from the S&P 500 Dividend Aristocrats, have already suffered dividend cuts. In just the last month, Dividend Aristocrats Pfizer (NYSE:PFE), State Street (NYSE:STT) and Masco (NYSE:MAS) made substantial dividend cuts. Another, General Electric (NYSE:GE), has a 12% yield suggesting they may have to cut their dividend.

Today's yields for junk bonds are probably at realistic levels (a good 1200 basis points above the 10 year Treasury bond yield) given the depressed state of the economy. Such rates and spreads should continue (if not rise) until the US economy recovers. But rates on junk bonds far exceed 1% rates (if that) available on idle funds and these low rates are not expected to increase for some time. Substantially higher rates tempt the very brave to invest a small percent of idle funds for the higher yields available on junk bonds.

Disclosure: No positions