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A Reason to Avoid Junk Bonds

It has been a good year for high-yield (junk) bonds…until recently.

On a quest for an alternative to low-yielding Treasuries and investment-grade bonds, investors have poured record amounts of cash (over $46 billion) into junk bonds this year.  And with that, the average junk bond yield was driven to a record low 6.205%…well below the historical 7% floor that investors consider acceptable compensation for taking on risk (because prices and yields move in opposite directions, when investors drive up prices, yields fall).

Lower yields mean it is cheaper for risky companies to borrow money by selling junk bonds.  So it’s no surprise that there has been a lot of junk bond issuance lately.

The problem is that “so much money has flooded into the junk-bond market from yield-hungry investors that weaker and weaker companies are able to sell bonds…and with yields near record lows, investors aren’t being compensated for that risk”, according to The Wall Street Journal.

And now the market is taking a breather.  After dumping money into junk bond funds for 15 straight weeks, investors are pulling cash back out.  October began with an outflow of $892 million in one week.

Investor sentiment and outflows aside, I don’t like junk bonds right now.  The market has been a little too frothy and crowded, and yields have been getting a little too low.


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