When Junk Bonds Are Just Priced Too Ugly (HYG, JNK, HYT, PHK, HYF)

Barron’s is talking up junk-rated debt.  We have been expecting that some media outlets would begin to notice how the spreads over Treasury yields were growing and growing and now offer 10% yields in some cases.  This should only highlight more value in what has been a battered sector, even if there is no way to know if the true bottom has been put in.

Andrew Bary noted, “The junk-bond market has taken a big hit. It might fall some more, but patient investors will be rewarded. Anyone in search of income should take advantage of the hefty yields.”  He noted that prices are down 10% since the end of July and noted that the junk spreads have widened out to about 900 basis points from just 475 basis points in April.

The market has not yet caught back on if the Europeans are going to come up with a solution that allows for investors to put their “risk” trades back on.  The high dividends from interest collected in high-yield funds and ETFs have attracted investors for years and years when the investors believe the risk-reward is very favorable.  When Treasury notes, bonds, and CDs pay so little, 8% and 9% spreads over Treasury yields should start attracting the vultures.

Two key ETFs for non-investment grade bonds are the iShares iBoxx High Yield Corporate Bond (NYSE: HYG) and the SPDR Barclays Capital High Yield Bond (NYSE: JNK) ETF.  The iShares iBoxx High Yield Corporate Bond (NYSE: HYG) is up 2.1% at $85.13 and it has a $77.90 to $92.85 range over the last 52-weeks.  The SPDR Barclays Capital High Yield Bond (NYSE: JNK) is up over 2% at $36.97, but it has a 52-week trading range of $34.09 to $41.32.

BlackRock Corporate High Yield Fund VI, Inc. (NYSE: HYT) is up 3.2% at $10.55 and its 52-week range is $9.94 to $12.23.

PIMCO High Income Fund (NYSE: PHK) is up some 4% at $11.84 and its 52-week range is $10.52 to $14.88.

Managed High Yield Plus Fund Inc. (NYSE: HYF) is up 3.7% at $1.94 and its 52-week trading range is $1.77 to $2.66.

Many of these were beaten up in sympathy with many other funds who had investments in sovereign debt of the PIIGS or in companies where the spreads were widening out substantially.  Earning a spread of 4.75% above Treasuries is already high, but a spread of 8% or 9% higher than Treasury yields starts to become astronomical on a risk-reward basis.  In short, a rise of that magnitude would be implying that expected default rates are going to rise from roughly under 2% to about 6% or more in the periods ahead.

If the United States manages to keep from falling back into a definite recession, the de facto yield spreads available in junk bonds have become a true bargain for income investors.

JON C. OGG