On October 4, 2011, spreads in the non-investment grade part of the corporate bond market reached a level of 910 basis points over Treasuries. If you were an investor on the prowl for so-called “junk bonds” to add to your portfolio, early October 2011 was a fantastic time to buy. Since that time, however, it slowly became more difficult to find enticing opportunities in the world of high yield bonds, as spreads have collapsed, falling all the way to 335 basis points on June 23, 2014 (see chart below). And then things changed.
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In just over one month, spreads erased six months of contraction, jumping 90 basis points to the recent high of 425 basis points on August 1. When digging a bit deeper, we find that CCC-or-lower-rated bonds experienced a recent spread widening of 126 basis points, single-B-rated bonds saw a jump of 99 basis points, and double-B bonds, not surprisingly, had the smallest rise in spreads at 73 basis points.
To be clear, current levels of non-investment grade corporate bond spreads are not at the point at which I would start buying junk bonds en masse. For the purpose of this article, rather than focusing on the absolute level at which spreads are currently trading, I would instead like to note the speed with which they rose.
Despite the fact that spreads may not be at attractive levels today, as a result of their turning notably higher (as they recently have), bond investors should begin following them closely, waiting for the opportunity to pounce. On February 21, 2011, the “BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread” was at 452 basis points. As I noted earlier, roughly six months later, in early October 2011, the spread had more than doubled, climbing to 910 basis points. It only took a bit more than six months of spread widening to erase approximately 18 months of spread contraction. And the final 118 basis points of widening happened in just five trading days.
Even though I suspect high yield spreads will return to a level over 900 basis points at some point in the coming years, it’s hard to say whether 2014 is the year that will happen. But with the myriad of global hot-button issues and events currently ongoing, combined with the recent spike in junk bond spreads, I think it’s time for bond investors to once again begin to pay close attention to the bonds on their watch lists. The best opportunities often only present themselves for a short period of time.
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