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High yield is a nice way of saying "junk" when talking about bonds. These bonds are issued by firms who must pay a higher interest rate when raising capital than those companies that issue bonds that qualify as investment grade. Those higher interest rates are attractive to investors and lately demand for high yield bonds has led to a very nice rally in junk bond funds like the iShares High Yield Corporate Bond Fund (HYG).Today, HYG is finally pausing in its uptrend as investors take some profits off the table across the bond market. Investors are concerned about the fact that the Treasury plans to flood the $112 billion worth of new debt into the market next week. That will be a record auction amount and could put temporary downward pressure on bond prices.
Sure junk bonds are risky but are they riskier than "growth" stocks? Because most stocks pay a nominal or zero dividend, the only way investors can profit is if future buyers bid up prices. In order for that to happen expectations for growth must increase in the future. If economic recovery takes longer than current optimists estimate stocks may wind up looking more like a Ponzi scheme than anything else.
Bonds, however, are designed to provide income based on current operations. If the debtor firm can keep making their payments, the bond holders will make money. This could be a good thing if stocks start to flatten out or decline in the near term.
In fact, quite often a decline in stocks coincides with a rise in bond prices as investors shift capital between markets. The downside to this scenario is that junk bonds act more like stocks than Treasuries or investment grade bonds and another serious economic shock could hurt these funds as much at it could damage stocks.
John Jagerson is a co-founder of Learning Markets, LLC. Learning Markets offers daily articles, videos and investing guides about everything from investing in stocks and options to trading currencies in the forex market and more.
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