Has the maximum point of stress in the capital markets passed?
There’s no one measure for answering the question. In fact, there’s no convincing answer short of letting time pass. But for those looking for a bit of perspective in real time, among the worthy gauges to watch in search of clues is the spread in junk bond yields over the 10-year Treasury yield. By that standard, a minor milestone recently passed considering that this spread touched a recent peak of 7.93% last month (based on closing yields on March 17, 2008), as our chart below shows. The question: Will the peak will hold?
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Only time will tell, of course. Meantime, what lessons does recent history offer? For starters, an investor who bought junk bonds as an asset class at the peak, i.e., at the close on March 17 is now sitting on a 4.5% return, based on the price change of iShares iBoxx High Yield ETF (HYG) from that date through last night’s close. So far, that’s middling compared with other asset classes. The S&P 500, for instance, has jumped 7.5% over the same period–as per the Spider ETF (SPY)–while U.S. bonds generally have slipped by around 80 basis points over those weeks, as measured by iShares Lehman Aggregate Bond ETF.
Buying when risk premiums are high, or selling when they’re low, is eminently reasonable and in the long run it may be the closest thing to a free lunch for strategic-minded investors. Accordingly, one might wonder if the 793-basis-point risk spread embedded in junk bonds last month was a buy signal for the long haul.
Perhaps. Looking at spreads going back to 1999, as we did last November, reminds that a near-800-basis-point risk premium looks pretty good based on the knowledge that the spread’s high point over the past 9 years is only modestly higher, at roughly 1,000 basis points, reached for a time in 2002.