A Quick Lesson In Dumpster Diving

| About: iShares iBoxx (HYG)

Summary

Let's take a quick look at high yield versus quality income stocks.

Can you guess which fares better over the long haul?

Think twice about those junk bonds.

This is going to be an illuminating (albeit short) one, because Lord knows I've spent plenty of time talking about how corporate management teams are influencing the share prices of their own stock (and thus boosting their own compensation) by taking advantage of Fed-engineered low borrowing costs to issue debt and use the proceeds for buybacks.

This practice also benefits regular shareholders, of course, because it reduces the float and thus (artificially) boosts EPS.

But most investors haven't taken the time to consider what this means. First of all, the "earnings" aren't real. They're inflated. Management reduces the share count and thus makes EPS look better than it normally would.

But second, and perhaps more importantly, they're using leverage to get this done. They're risking the balance sheet (i.e., taking on more debt) and spending the proceeds on what amounts to an optical illusion rather than on capex or, productive capacity, that can be utilized when the economy turns.

I'll go over this in detail in another piece (as I have before), but for now, I wanted to highlight a few charts I found for you.

There are a lot of folks out there who insist that HY (NYSEARCA:HYG) credit is the only way to go these days. After all, it's a "hunt for yield," right? Where else can you turn?

I've long argued that this, for lack of a more elegant term, is stupid. They're called "junk" for a reason. And that's exacerbated by the lack of liquidity for these issues in the secondary market. The long and the short of it is this: why would you buy a junk bond ETF (NYSEARCA:JNK) when you could buy quality equity income stocks instead? If you're an average investor, that is?

The truth is, you wouldn't.

Let me show you why, courtesy of SocGen. Have a look at the following:

Click to enlarge

(Chart: SocGen)

So the first thing you'll notice here is that since the crisis, you'd have been just as well off owning select high-quality income stocks as you would have HY corporate bonds.

Click to enlarge

(Chart: SocGen)

Next, you can see that the risk (in terms of max drawdown) isn't really that much greater dating back nearly 15 years.

Click to enlarge

(Chart: SocGen)

Third, have a look (above) at the quality distribution, which frankly speaks for itself. What would you rather own?

Finally - and perhaps most tellingly - have a look at the total return disparity dating back to the start of the great bond bull market:

Click to enlarge

(Chart: SocGen)

So do yourself a favor - don't go dumpster diving in bonds right now. At least back then, the Street would inventory them for you. These days, you'll end up stuck with them.

And for what?

SocGen's research suggests "for nothing."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.