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- February 1, 2013
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Nobody brags about buying high-yield bonds at cocktail parties. But…
High-yield bonds have actually equaled the return of stocks over the last 25 years… And they’ve done it with half the risk (half the volatility).
High-yield bonds – also called “junk bonds – are bonds that are rated below BBB or Baa (depending on the ratings agency). These bonds are officially considered “speculative-grade” bonds by the ratings agencies.
Most people are afraid of “junk” bonds – simply because of the name. But the name doesn’t match up with reality today.
As I mentioned, over history, the investment returns on junk bonds haven’t been “junk” at all. They have been GREAT.
There are times when it’s dangerous to buy “junk” bonds. But right now is the OPPOSITE of that. Right now is actually a fantastic time to buy them. You are getting paid way more in interest in junk bonds today than you “deserve” to get, relative to the amount of risk you are taking. This situation won’t last.
I say this for two reasons – 1) the spread and 2) the default rate.
Specifically… junk bonds are currently paying about 8% interest. Ten-year Treasury bonds are paying about 2%. So junk bonds are paying an enormous 6% interest “spread” over Treasurys.
The spread over Treasurys has been this high or higher only three times in the past: in 1991, 2002, and 2009. Every time, high-yield bond prices absolutely soared in the following years. Take a look:
Right now is different from those last three times. It’s better. Right now is a much less risky time to invest in high-yield bonds…
In each of those three previous instances, high-yield bonds were defaulting left and right. In each of those three cases, the default rate on these bonds was over 10%.
But today, high-yield bonds aren’t crashing at all. Today, the default rate on speculative-grade bonds is closer to 1.5%.
In short, high-yield bonds are priced as if the world is ending (as if the default rate were 10%) – but the world isn’t ending (the default rate is near 1.5%). This is a ridiculous opportunity.
I see a big rally coming in high-yield bonds this year…
I envision hordes of retirement-plan managers desperate to figure out where the heck they’re going to find interest in our zero-percent world. They will be stressing out. And they will land on high-yield bonds sometime soon.
High-yield bonds are in a ridiculously good sweet spot, paying a high interest rate relative to other investments, but having a low default rate. This simply doesn’t happen.
Money managers will soon realize that the returns in high-yield bonds today are very high, relative to the default rates… And these investment managers NEED those returns to keep their jobs. So they’ll be big buyers in 2012.
You can beat them to it… and earn the capital gains as they follow you into it.
You are set for high interest and solid capital gains in an investment that is in its “sweet spot.” The simplest way to get in is through a fund of high-yield bonds, like the iShares High-Yield Corporate Bond Fund (HYG), paying 7.26% interest.
Right now is a great moment in high-yield bonds. Don’t miss it.
– Steve SjuggerudSource: Daily Wealth