No. of Recommendations: 6
<“What you’ve basically seen is people who don’t really want to take more risk being forced up the risk curve to get the yield they need,” says one London-based bond trader. ... S&P noted with alarm that despite its risk models showing that the probability of high-yield companies defaulting had nearly doubled in the past 12 months to a one-in-three chance, the yield on the bonds had halved over the same period as money continued to flood in. ... >

These charts tell the story.

The High Yield Bond CCC or Below Effective Yield is the lowest on record, except for 2007 (pre-crisis) and the short period in 2011 before the Greek default crisis erupted.

http://research.stlouisfed.org/fred2/series/BAMLH0A3HYCEY

However, the US High Yield CCC or Below Option-Adjusted Spread is significantly higher than it was in 2007 because Treasury yields have been pushed so low. Even though buyers are stretching for yield, they have not thrown caution to the wind by cutting spreads to the bone as they did pre-crisis.

http://research.stlouisfed.org/fred2/series/BAMLH0A3HYC

As soon as Treasury yields begin to climb, the value of these bonds will plunge, unless the cause is a great economic recovery (because junk bonds act a lot like stocks -- the weak companies default less in a good recovery).

Because of the wider spreads, I don't expect the collapse to be as stark as it was in early 2009, possibly (hopefully) the greatest bond-buying opportunity of our generation.

Wendy
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