As Bond Yields Continue To Drop, Investors Should Start Looking Elsewhere

Includes: DIA, JNK, SPY, T
by: Matt Schilling

Should investors take Bill Gross' advice and shift their sentiment toward an investment in bonds, and more specifically junk bonds? Any financial instrument that currently yields better than your average savings account may be something to consider, but I really don't think right now is the ideal time to jump head first into a pool that continues to demonstrate a slow, yet steady decline in its water level. In an effort to be a bit more specific about my analogy, I happen to be talking about junk bonds. As many investors know most of these bonds have seen a very sharp decline in their yields as of late and as a result hit another all-time low Friday when they closed at 6.189%.

According to an article featured on,

The average junk-bond dollar price is back up to 104.12 cents on the dollar, in close range of its record-high 104.2-cent price seen last month and above the key 103-cent call-constrained price. The junk bond market has now returned 13.455% in 2012 to date, and the average junk bond now trades at a spread of 524 basis points over Treasuries, which is slightly above its historical norm, due mainly to Treasury yields that remain near historic lows.

If Treasuries continue to stay at or near all-time lows, junk bond yields may suffer, and as a result investors would need to begin to consider alternative investment options.

In my opinion there are two options investors may want to consider. The first option to consider would be for investors to avoid junk bond-related ETFs such as the SPDR Barclays Capital High Yield Bond (NYSEARCA:JNK) and possibly consider index-based ETFs such as the SPDR S&P 500 (NYSEARCA:SPY) or the SPDR Dow Jones Industrial Average (NYSEARCA:DIA). Why? Junk bond ETFs are made up of various junk bond investments and given the fact yields are on the downswing, now might not be such an ideal time to establish a position in the sector. The comparable year-to-date performance of JNK vs. SPY and DIA has been dismal. In terms of year-to-date returns DIA has returned 9.20% to investors, while SPY has returned 14.30%, both of which outpace the 5.10% year-to-date return of JNK.

The second option investors should consider would be the potential establishment of a long-term position in a high-yielding blue-chip company which outpaced the S&P 500. Why? Given the fact that junk bond investors are highly attracted to yields they pay, finding something in the high 4% to low 5% range may be a good suggestion. From an income perspective AT&T (NYSE:T) may not be such a bad choice, considering the fact the company yields 4.90% ($1.52), and has demonstrated a year to date return of 16.80% which outpaces the S&P 500 by a ratio of 1.37 to 1. According to my fellow SA colleague, Tradevestor, AT&T is poised for another dividend increase and very soon for that matter,

AT&T went ex-dividend on October 5th for a dividend of 44 cents a share, the fourth consecutive quarter the same payment has gone out. This means, a dividend increase is in the cards given AT&T's history of increasing dividends for nearly 30 years. Granted, the stock has not been growing dividends at a frenetic pace recently but any increase is good for investors when the other 'safer' alternatives yield much lower.

One the negative catalysts currently hanging over the heads of shareholders is the chance, though slim, that AT&T may suspend its dividend at some point in the next five years as part of an effort to satisfy the $9.2 billion dollar deficit current pension plans are facing. Though I highly doubt it would happen, it's still something potential investors should keep in the back of their minds.

Final Analysis

As many of us are already aware, the US economy is in a very fragile state. Given its fragility, bonds may not be the best of investment options at this time for three very important reasons. First, junk bonds tend not be diversified, and therefore run the risk of not being paid back. Second, the decrease in bond yields may not even be close to a bottom considering the fact they may go even lower than the 6.189% level they stand at presently. Lastly, diversified investments (even those that yield higher than 4%) still provide very good long-term income streams without all of the risk factors of junk bonds and potential investors looking for a stable investment with the possibility of an income stream should consider the options I've detailed rather than investing directly in those funds.

Disclosure: I am long T. 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.