Doin’ the Grind

Are junk bonds really golden?

Since the march lows, junk bonds have been on a roll, adding over 40%. At the same time, investment grade debt has grown, although not as much, advancing about 15%. But in the past week the situation has gotten confusing. Most corporate bonds have fallen, while junk bonds continue their roll.

So what gives? Part of the answer lies with corporate “spreads.” Corporate bonds are usually quoted at their “spread” above US Treasury bonds. Generally, the riskier the bond, the wider the spread. Earlier this year, as we stared into the abyss of a potential depression, all credit spreads were wide. Really wide. Since that time, all spreads have declined, pushing up prices.

In the process, junk bond spreads have come in more than corporate bond spreads and the prices have advanced more. But both types of bonds have improved. At the moment, junk bond spreads continue to grind tighter, but corporate spreads seem to have stalled out. They’ve come in just so far and no farther.

So corporate bond prices are more subject to the Treasury market now than they have been up to this point. And Treasuries got hit hard last week as they auctioned off $12 billion in 30-year bonds. The junk market didn’t care all that much. But corporate bonds went down.

So it looks now like the markets are diverging. There still are plenty of attractive places to put your money to work. But as bond spreads grind tighter, they’ll act more and more alike. Right now corporate are acting like Treasuries. Junk bonds won’t be far behind.

Douglas R. Tengdin, CFA
Chief Investment Officer
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