When growth prospects are positive, investors are confident, defaults are low or falling, and yield spreads allow for more appreciation, high-yield bonds perform well. Investors should, however, always base their decisions on their long-term objectives and risk tolerance. These criteria can help you figure out when it’s the best time to buy.
Is now a good time to invest in high yield bond funds?
High-yield bonds are neither good nor bad investments on their own. A high yield bond is one that has a credit rating that is below investment grade, such as below S&P’s BBB. The higher yield compensates for the higher risk associated with a lower credit grade on the bonds.
Higher-quality bonds’ performance is less associated with stock market performance than high-yield bonds’ performance. Profits tend to drop as the economy suffers, as does the ability of high yield bond issuers to make interest and principal payments (in general). As a result, high yield bond prices are falling. Declining profits also tend to decrease stock values, so it’s easy to understand how good or negative economic news could drive equities and high yield bonds to move in lockstep.
How do high-yield bonds look in the future?
According to a recent J.P. Morgan prediction, $200 billion in high yield bonds will be moved to investment grade by the end of 2022, with an additional $50 billion moving to IG in 2023.
Are high-yield bonds a suitable investment during an inflationary period?
With good cause, inflation has been a hot topic. Inflationary measures have been nothing short of historic in recent months. Recent data, however, appear to show a cooling, with numerous commodities trading well below their highs, the Chinese economy and markets in turmoil, the COVID-19 Delta variant affecting economic activity, and mounting geopolitical tensions. There appears to be no shortage of causes that could cause inflation to slow or moderate. Is this to say that investors may ignore inflation and focus on other things? We feel that is premature, and that it is still prudent to assess the effects of inflation on different asset classes.
The broad-based character of input-cost inflation, which spans raw materials, logistics/transportation, and labor, as well as shortages of intermediate items like semiconductors, distinguishes the current scenario. This, along with pent-up demand as economies reopen and consumers have more money in their pockets, gives businesses a remarkable amount of pricing leverage.
Our corporate credit team has been listening in on earnings calls, management commentary, and industry data to analyze inflation’s continued importance and potential consequences for the US high yield corporate bond market. A few things have become clear as a result of this investigation:
- Even if inflation moderates, the effects of the recent steep increase are likely to be felt for several more months, if not quarters.
- Input-cost inflation is expected to have a stronger impact on some industries than others.
- In most circumstances, high yield corporate lending in the United States should be able to withstand inflation.
Inflation will almost certainly continue to rise in the coming quarters. According to management commentary on second-quarter 2021 earnings calls, most input cost pressures have not abated, and in many cases have deteriorated since the beginning of the year. Several automakers, for example, have reported higher-than-expected losses due to semiconductor shortages, increased freight and transportation costs, and higher raw material prices. Semiconductor shortages, which were supposed to ease in the second half of the year, are now expected to persist beyond 2022, with supply bottlenecks likely to continue. In the chemicals industry, the impacts of winter storm Uri are still limiting the availability of plastics, which are utilized as an intermediate good in a wide range of products, while Hurricane Ida threatens to compound the situation.
Meanwhile, domestic equipment and labor shortages, as well as international port closures and labor shortages caused by COVID-19 infections, have resulted in delayed and dislocated ships and containers, are driving up shipping costs. While the domestic labor scarcity may ease in the short term as unemployment benefits run out and children return to school, shipping and logistics costs are expected to stay high at least through the fourth quarter of this year. This indicates demand as retailers try to restock already-depleted supplies and stock appropriately for the holidays, as well as the ongoing effects of international disruptions.
To mitigate the impact on margins, companies are relying primarily on price, in addition to productivity and cost-cutting measures. Companies in several industries have contracts in place that allow them to pass on increases in input costs to their customers, but these price increases are frequently delayed. Other businesses have announced intentions to raise prices over several months or quarters in order to avoid upsetting customers or risking a surge in demand. Many companies mentioned taking one or more rounds of price hikes during their second-quarter results calls, with some committing to more price rises and others stating they’ll take additional pricing if needed. Price hikes will be seen throughout the supply chain for at least the next quarter or two, with certain moves continuing into 2022.
Input-cost inflation is expected to have a stronger impact on some industries than others. We looked at the following factors to see how various high-yield sectors might fare during the present inflationary period:
- Input-Cost Inflation: How inflationary pressures in raw materials, transportation, and labor, as well as shortages of intermediate goods like semiconductors, affect a certain industry.
- Pricing Power: The likelihood that issuers in a certain industry will be able to offset increasing input costs by raising prices.
- Impact on Earnings: How much of an impact would input-cost inflation and higher pricing have on profitability? This takes into account both the degree of pricing power and the potential for price increases to cover greater input costs to be delayed.
- Repricing Vulnerability: The degree to which a given industry is vulnerable to bond repricing due to the impact on earnings from rising input-cost inflation, taking current trading levels into consideration.
This analysis reveals that specific industries, such as automotive, consumer products, food and beverage, and retail, are at a higher risk of negative bond repricing. Sectors like energy exploration and production and metals and mining, on the other hand, are likely to gain from rising commodity prices and have more upside than downside repricing potential in this framework.
We discovered that over half of the ICE BofA US High Yield Constrained Index is in industries with minimal repricing susceptibility, and another 20% is in industries that would profit from increased commodity prices, using this methodology and then taking into consideration the weighting in the index.
1 Only roughly a quarter of the index is made up of industries that are at high risk of repricing due to inflationary pressures, with only a tiny subset of these industries having a significant potential for repricing. It’s also worth noting that some of these businesses may benefit from other offsets, such as increasing volumes, which could help to mitigate the risk of repricing due to rising input costs.
As a result, we anticipate that the overall impact of prospective input-cost inflation and shortages on credit fundamentals on US high yield corporate bonds will be limited, while we believe there are benefits to be derived via judicious industry weighting and credit selection.
One must also examine how a rise in Treasury yields in reaction to higher-than-expected inflation estimates will affect the asset class. Given that spreads are still wide of historic lows across ratings tiers and the default rate is anticipated to remain very low at least through 2022, we believe that US high yield spreads have capacity to contract to absorb a modest rise in Treasury yields.
Why are high-yield bonds losing ground?
Reuters, 2 December – In November, high-yield bond funds in the United States suffered their largest withdrawals in eight months, owing to the possibility of the Federal Reserve hiking interest rates sooner than expected, as well as, to some extent, fears about the Omicron coronavirus variety.
Do high-yield bonds pose a greater risk than stocks?
When you buy corporate bonds, you become a creditor of the corporation. While stockholders are promised nothing, bondholders are entitled to interest payments (save for zero-coupon bonds) as a creditor on their bond purchase, as well as the assurance that the bond will be returned in full at some point in the future (assuming the firm does not go bankrupt). High-yield corporate bonds are considered less risky than stock investments since they have less volatility.
Are high-yield bonds a better investment than stocks?
- High-yield bonds provide stronger long-term returns than investment-grade bonds, as well as superior bankruptcy protection and portfolio diversity than equities.
- Unfortunately, the high-profile demise of “Junk Bond King” Michael Milken tarnished high-yield bonds’ reputation as an asset class.
- High-yield bonds have a larger risk of default and volatility than investment-grade bonds, as well as more interest rate risk than equities.
- In the high-risk debt category, emerging market debt and convertible bonds are the main alternatives to high-yield bonds.
- High-yield mutual funds and ETFs are the greatest alternatives for the average person to invest in trash bonds.
What will happen to bonds in 2022?
- Bond markets had a terrible year in 2021, but historically, bond markets have rarely had two years of negative returns in a row.
- In 2022, the Federal Reserve is expected to start rising interest rates, which might lead to higher bond yields and lower bond prices.
- Most bond portfolios will be unaffected by the Fed’s activities, but the precise scope and timing of rate hikes are unknown.
- Professional investment managers have the research resources and investment knowledge needed to find opportunities and manage the risks associated with higher-yielding securities if you’re looking for higher yields.
The year 2021 will not be remembered as a breakthrough year for bonds. Following several years of good returns, the Bloomberg Barclays US Aggregate Bond Index, as well as several mutual funds and ETFs that own high-quality corporate bonds, are expected to generate negative returns this year. However, history shows that bond markets rarely have multiple weak years in a succession, and there are reasons for bond investors to be optimistic that things will get better in 2022.
Is bond investing a wise idea in 2022?
If you know interest rates are going up, buying bonds after they go up is a good idea. You buy a 2.8 percent-yielding bond to prevent the -5.2 percent loss. In 2022, the Federal Reserve is expected to raise interest rates three to four times, totaling up to 1%. The Fed, on the other hand, can have a direct impact on these bonds through bond transactions.
Is now an appropriate time to sell my bonds?
When interest rates are expected to climb dramatically, this is the most important sell signal in the bond market. Because the value of bonds on the open market is primarily determined by the coupon rates of other bonds, an increase in interest rates will likely lead current bonds your bonds to lose value. As additional bonds with higher coupon rates are issued to match the higher national rate, the market price of older bonds with lower coupons will fall to compensate new buyers for their lower interest payments.
Is it better to have higher or lower yields?
- The low-yield bond is a preferable choice for investors looking for a virtually risk-free asset or for hedging a mixed portfolio by keeping a portion of it in a low-risk asset.
- The high-yield bond is ideal for investors who are willing to take on some risk in exchange for a larger return. The corporation or government issuing the bond runs the risk of defaulting on its debts.