Junk bond funds have been one of the best performing sectors in the last year. Many have doubled from the days when their yields were above 20%. Junk bond prices kept rising in 2010 as investors bought bonds, including the heavy supply of new bonds coming to market.
Then came May, one of the worst months in history for junk bonds. In 3 weeks, junk bond funds dropped 20%, followed but a sharp reversal on May 25. However, junk bonds are still down a good 10% in May, as investors demand higher returns on risky borrowings. European debt problems are bleeding across the Atlantic to the US.
Greek debt problems received a lot of publicity, highlighting the fragility in the European financial markets. Since investors didn't like what they saw, they sold stocks and bonds, especially high yielding securities. Risk aversion and selling high yielding securities (like junk bonds) to buy Treasuries is back in vogue. The VIX (Volatility Index, aka fear index) shot up from 16 to the 40s before settling back to 35, which is still very high. Investor fear is clearly running very high.
Treasuries are viewed as the ultimate risk-free investment (ok, they rival gold). In early April, the yield on the 10-year Treasury bond was pushing 4% with talk about higher interest rates around the corner. In the face of massive Treasury auctions, with many topping $100 billion, investors demanded Treasuries, pushing yields to their lowest levels in the last year. The yield on the 10-year Treasury bond has fallen to near 3.2%, even though the Treasury has virtually promised 10 years of massive new borrowings. The government just announced Treasury borrowings went over $13 trillion.
European debt problems are not going away soon. Today ,Spain and Italy tried to explain the fixes they were making in order to ease the fear about European debts. Spain combined 3 savings banks, which will not result in job losses, and Italy will enact large budget cuts (don't bet on it). European leaders are solving difficult problems by making it up as they go along. Markets sold off in the afternoon, a thumbs down reaction.
Junk bond fund yields have risen to the 10-11% area. The spread over the 10-year Treasury is 7-800 basis points, a little more understandable than roughly 500 basis points (where it had been) given the state of the US and global economic recoveries. There is a greater awareness by the markets that junk bonds are bonds with high risks which should be reflected in their yields. Volatility for junk bond funds is substantially higher than it has been for much for this year with a bias is on the downside (for bond prices).
Disclosure: No positions