New data showing jobless claims have risen to the highest level in three months may mean more trouble for the already-reeling junk bond market.
Even before the unemployment numbers were released this morning, yields on junk bonds were rising (yields rise when bond prices drop). The average junk bond now pays 6.2 percentage points over comparable Treasurys, up 0.5 percentage points from a month ago, says John Lonski, chief economist for Moody’s Analytics. Financial advisers say that spread may widen, since junk bonds are among the investment assets that are most sensitive to economic news and changes in economic sentiment. “Investors have become more risk averse,” says Lonski.
Indeed, fund investors have begun to bail from the high-yield market. According to the most recent data available, investors pulled $1.4 billion from high-yield bond funds in the week ended April 11, ending an 18 week streak of inflows, according to fund research firm EPFR Global.
Experts say the rise in jobless claims is reigniting concerns that the economic recovery is stalling. Earnings, which are growing at much slower pace than last year, could shrink further if consumer sentiment and spending hit the skids, says Wilmer Stith, portfolio manager of the $295 million Wilmington Broad Market Bond fund (AKIRX). That would increase the risk in high-yield bonds. Average bond defaults rose to 2.8% for the 12 months ending in March, from a low of 1.9% in December 2011, says Lonski.
To be sure, any rebound in jobs or the overall economy could reverse the move out of junk bonds. Strong demand in the technology sector and an increase in U.S. exports could bring weekly jobless claims back down, says Stith.
In the meantime, some advisers and fund managers are scaling back their clients’ exposure to high-yield bonds. Stith is steering clear of buying more junk bonds, instead adding more investment grade corporate bonds and mortgage-backed securities. And Michael Collins, a senior investment officer at Prudential Fixed Income, is snapping up higher-quality junk bonds, which offer attractive yields but also carry less risk of default. For instance, bonds rated BB, the highest credit rating for a junk bond, pay about 3 percentage points more than bonds rated BBB, or investment grade. “It just seems like a great risk return trade-off for me,” says Collins.