Word of Caution on the Rising Popularity of Junk Bonds

“Strong investor demand for higher yields continues to allow all but the weakest issuers to avoid default by refinancing maturing debt,” Verde added. “A number of very weak issuers are living on borrowed time while benign conditions last.”

Goldman Sachs has also warned about the rising risks in high-yield debt. Goldman’s preferred valuation measure of corporate credit, which subtracts projected expected-loss rates from current spreads, reveals U.S. high-yield obligations are now mispriced for even the most benign of scenarios, Bloomberg reports.

“In a nutshell, the CRP is the expected excess return on a buy-and-hold strategy of diversified credit portfolios over a five-year period,” Goldman analysts led by Chief Credit Strategist Lotif Karoui said in a note. “Put differently, the CRP is the extra premium earned by investors as compensation for future default losses.”

Goldman calculated that the credit-risk premium for CCC-rated debt has sunk to a negative 53 basis points, “even under a fairly optimistic assumption of no recession for the next five years.” This is the lowest level since before the financial crisis when the CRP was at negative 420 basis points in June 2007.

“The key takeaway: the premium currently embedded in high-yield spreads is mispriced even if default losses do not ratchet up to recession-like levels,” the analysts added. “Aside from energy, we continue to see little value in CCC-rated bonds at current levels.”

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