All those bond investors fretting about a bubble will probably be right eventually. In the meantime, they may want to think about buying some junk debt.
That’s how Bob Michele, who oversees $380 billion as JPMorgan Asset Management’s chief investment officer for fixed income, is approaching the market. Just because yields on speculative-grade debt are falling toward the lowest ever, that’s not a good enough reason to avoid it, he said.
“Ultimately there will be a bubble,” Michele said in a Bloomberg Television interview on Aug. 26. As for now, he said, “there’s only so long that you’re going to sit in cash earning a zero percent return in the U.S., perhaps a negative yield in Europe, before you go back into some form of bonds.”
Michele isn’t alone in seeing value in junk bonds despite Federal Reserve Chair Janet Yellen’s suggestion that the market has gotten frothy. While high-yield notes in the U.S. posted a 1.3 percent loss last month, their first in almost a year, they’ve bounced right back with a 1.5 percent gain in August, Bank of America Merrill Lynch index data show.
The reason yields are so low is because of the Fed’s easy money policies, which are ongoing (even if a little scaled back).
So why leave now when the party’s still good?
Not Much Upside
It’s understandable why investors would be wary of plunging into less-creditworthy debt right now. Junk-rated bonds are yielding 5.9 percent as measured by Bank of America Merrill Lynch index data. That’s about 0.2 percentage point from the all-time low, meaning potential returns are significantly less than the historic average.
While mutual-fund investors yanked a record $7.1 billion from the debt in the week ended Aug. 6, they’ve since had a change of heart, plowing $2.9 billion back into the funds in the two weeks since, according to data provider Lipper.
“Everybody has been lulled into this comforting notion that between a Goldilocks economy, not lifting off but not collapsing, and the Fed being the market’s best friend, it’s OK to leverage every risk factor,” Mohamed El-Erian, former chief executive officer of Pacific Investment Management Co. and Bloomberg View columnist, said in an interview last week.
“Everybody’s in the same trade,” he said. “If sentiment changes, there’s no shock absorber in the system.”
Call it a game of chicken, where investors wait as long as they can before slipping out just before everybody else runs for the exits. Or perhaps another case of don’t fight the Fed, which has pledged to keep benchmark rates low for a prolonged period.
“Typically you see bubbles at the end of Fed tightening, when the Fed has withdrawn liquidity from the system,” Michele said.
That’s not happening yet. So for now, game on.
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