Junk-Bond Buyers Overreaching as Yields Approach Lows, BofA Says

Bank of America Corp. warned investors not to overreach in the junk-bond market as company inventory costs outpace revenue growth, threatening to end a rally that has pushed yields to almost record lows.

Revenue growth for the more than 200 high-yield, high-risk issuers that have reported their second-quarter results was 1.5 percent, compared with a rise in inventory costs of 2.2 percent, Bank of America credit strategists led by Hans Mikkelsen and Oleg Melentyev in New York wrote in an Aug. 6 report.

“This is not a sustainable state of affairs, and we would expect to see further steps in addressing cost structures going forward, meaning further cutbacks in payrolls, new orders” and capital expenditures during the three months that will end Sept. 30, the analysts wrote. “While the bid for high-quality yield is understandable in this environment, we question the extension of this reach into the economically and risk appetite-sensitive portions of the credit spectrum.”

The so-called yield-to-worst for U.S. junk bonds are 20 basis points, or 0.2 percentage point, above the record low average of 6.7 percent, the strategists for the Charlotte, North Carolina-based bank said. The measure, which takes into account the risk that bonds will be redeemed early, leaves little opportunity for price gains, they said.

Junk bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s, have returned 9.7 percent this year, according to Bank of America Merrill Lynch’s U.S. High Yield Master II Index.

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