High Yield Bond Spreads: A Rocket Ship To Safety

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Includes: HYG, LQD
by: Don't Quit Your Day Job

Back in December, we penned a brief piece on the rapid rise of low-quality bond yields -- the price was dropping out of the things, and it made a very impressive rocket-ship looking graph.

Turns out, we were early on that trend -- the last 6 weeks have seen the spread move further up and to the right. To wit, here's the Bank of America Merrill Lynch CCC- Effective Yield chart through January 20:

Click to enlarge

The CCC- Yield Rocket Ship of 2015-16

A Flight to Quality

One of the more important reasons to track high yield bonds isn't to look for an attractive entry point -- I'd argue (and who'd disagree at this point?) that it's still too early to make a move into a high yield fund. No, dear reader, it's important to track below investment grade bonds to get a bead on what your fellow investors are thinking. If the spread between low-quality corporates and high-quality corporates is rising, that indicates fear in the market as people reduce the amount of risk in their portfolios and shift to higher-quality -- and higher-rated -- assets.

So, let's do that now.

Here's the graph of the spread between yields on AAA corporates and CCC and Below corporates, in all of its glory (courtesy Bank of America Merrill Lynch's indices):

Click to enlarge

(You can find the data on the Federal Reserve Bank of St. Louis's FRED here)

Now, obviously, it's hard to eyeball the total return on securities from a chart, so we built 3 calculators to do the math for you (including for that CCC- chart there):

Quick math on the timeframe in the chart: from January 20, 2012 to January 20, 2016 CCC and below rated bonds would have returned 6.917% total.

Your Investment Move?

Eventually, risk is priced at a level that just doesn't make sense -- but I'm not sure it's there yet. Your moves are probably:

  • HYG, the High-Yield corporate bond ETF fund from Barclays
    (or if you agree it's too early but want a corporate debt ETF)
  • LQD, from iShares, on the Investment-Grade corporate bond front

(Disclosure: I own neither).

But hit me with your best investment hypothesis.

Or, you know, tell me the best way to pay no attention to the market and come back in a couple months. Your call.