Okay, love may be a strong word to describe these colorful data points plotted below. But I do not think investors are paying these enough mind.
Everyone has said interest rates will rise, usually generically referring to the 10-year bond. Investors crowded into short duration bonds to avoid a rise in interest rates. Interestingly from a year ago, what area actually had a tougher time? The short duration bonds (blue line, orange dots). Note that the 2-7 year area of the curve all rose relative to 1 year ago. The 10-year and 30-year yields are both lower.
This is a chart of bond prices for CCC-rated companies. These are companies having a tough time making payroll with 50% defaulting within five-years of issuance. Investors are so starved for yield that they are paying above par for the privilege of lending to these junk rated companies! Since 1986 according to Standard & Poor’s, the cumulative default rate over a 5-year period for this group is 50%, making this area of the corporate bond market a very risky proposition at today’s prices.
The recovery in bond prices over the last year has seen investors warm back up to anything with a yield, including REITs and MLPs. Flows are climbing back, but still negative on the year. Rather than worry about the next price swoon, as investors may try to get out of the door all at once, see it as an opportunity to buy undervalued assets.
- There is more risk in short bonds than investors appreciate.
- High yield bonds are priced to perfection, beware of where they could be hiding in your “Income funds” reaching for yield.
- Keep an eye on areas where flows are negative, as these can present opportunities.
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