The Economy

Is the Winning Streak for High-Yield Bonds Over?

More than 200 speculative-grade issuers have been downgraded by S&P this year.
Katie Kuehner-HebertJuly 7, 2015

As the Federal Reserve’s easy-money policies may soon come to an end, so too will six straight years of gains for high-yield bond investors, Bloomberg said Monday.

U.S. high-yield companies posted two consecutive quarters without earnings growth for the first time since the financial crisis, and debt levels are 4.7 times earnings, the highest they’ve ever been, according to Bloomberg. As a result, Standard & Poor’s so far this year has downgraded 224 high-yield companies and upgraded 126 — the worst ratio since 2009.

Such companies have now left themselves little wiggle room to withstand an interest rate hike, said Bank of America’s head high-yield strategist Michael Contopoulos.

“The longer-term prospects for the asset class are worrying,” Contopoulos told Bloomberg.

High-yield bonds lost 1.52% last month — their worst month since September, according to Bank of America Merrill Lynch indexes. The losses wiped out the quarter’s gains, putting the returns for investors at 2.5% for the year. Contopoulos forecasts returns as low as 2% for 2015.

Markets are “extremely overheated,” particularly U.S. speculative-grade corporate bonds, investor Carl Icahn wrote on Twitter.

“If more respected investors had warned about the market in ’07, we might have avoided the crisis in ’08.” Icahn tweeted.

However, some investors, such as DoubleLine Capital manager Bonnie Baha, are not keen on dumping high-yield debt just yet.

“At some point the day of reckoning is coming for the high-yield market, but that could be a few years away,” Baha told Bloomberg, who also believes that there’s “no inflation in the system” to justify the Fed raising interest rates this year.

Even if the Fed did raise rates, many junk-rated issuers should be able to withstand it because they took advantage of cheap borrowing costs to push out maturities, Goldman Sachs analysts said. Roughly 64% of the outstanding debt doesn’t come due until 2019 or later.