Today’s Wall Street Journal has a story suggesting that high yield bonds’ days of flying high may be numbered. Perhaps, although in the year-to-date rankings for the major asset classes, junk bonds aren’t yet waving the flag of capitulation.
Surrender thus far in 2007 remains contained to REITs, which are in the red through yesterday to the tune of -3.1%, as our table below shows. High yield bonds, by contrast, are still up by 1.6% through July 9.
Then again, don’t let YTD numbers fool you. As the Journal article reminded, there’s a number of reasons to wonder how long the junk rally can last. Indeed, the asset class of junk bonds has posted a gain in each and every calendar year starting in 2001. But signs of pressure are building, starting with the fact that the average high yield bond trades at yield premium of around 300 basis points over comparable Treasuries–down from 1000 basis points in 2002, the paper reported.
Of course, the compression of risk premiums is nothing new. Your editor has mentioned the trend more than a few times over the past year or so, only to watch Mr. Market ignore the advice.
Clearly, we have no influence in the wider world, but the fact remains that all the major asset classes have rallied together and for several years, suggesting that something may soon give. Measured over the past month, junk seems to be doing its fair share of giving. The Vanguard High Yield Fund (which we use as proxy in the table above) has shed 1.5% in the past four weeks, according to Morningstar.com. That compares with a 2.5% loss in Vanguard REIT Index Fund over the same period.
No one knows if more selling is coming. Judging by the last few years, however, tumbles have been a prelude to even higher prices. It’s been the iron law for REITs, emerging market stocks, and other asset classes. But even iron laws melt under sufficient pressure. Alas, we can’t say for sure when sufficient pressure will arrive. The next best thing is recognizing the warning signs and having cash at the ready for exploiting a meltdown.