Not even escalating geopolitical conflicts can grind this rally in high-risk debt to a true halt.
Consider this: High-yield bonds are up 0.35 percent for August, gaining again after posting their first monthly loss in almost a year. The market’s poised for an annual return of 7.6 percent, building on a 135 percent return in the previous five years.
And this: Investors are also bidding up credit-focused closed-end funds that use borrowed money to amplify bets. They have returned 6.7 percent so far this year, on pace for 11 percent returns, according to a First Trust Portfolios LP index tracking the funds.
There’s nothing obvious to stop this rally, even as some of the biggest investors warn of escalating risks stemming from a sixth year of unprecedented stimulus from the Federal Reserve. Those easy-money polices keep fueling demand for higher-yielding securities.
Fed Chair Janet Yellen has suggested “and I agree that we are in an asset bubble,” Carl Icahn, the billionaire activist investor, wrote yesterday in an blog posting. “We can no longer simply depend on the Federal Reserve to keep filling the punch bowl.”
Even a U.S. Treasury committee this month discussed whether markets had become “too complacent,” especially as cutbacks at bond dealers may make “the system less able to deal with unexpected volatility,” according to meeting notes.
Yields on high-yield bonds have shrunk back down to within 0.44 percentage point of the all-time low, according to Bank of America Merrill Lynch index data.
As investors become complacent, “they start to employ a bit of leverage,” Jeffrey Sherman, a money manager at DoubleLine Capital LP, said in a Bloomberg Television interview today. “The biggest risk that overhangs the market right now is that if investors rush to the exits.”
Enter leveraged closed-end funds. Pacific Investment Management Co.’s $1.6 billion High Income Fund has gained 17.1 percent so far this year, while BlackRock Inc.’s $693 million Multi-Sector Income Trust has returned 10.2 percent, according to data compiled by Bloomberg.
Icahn may be right that the market’s heading toward a bad ending. For now, however, he’s left watching as signs of leverage and risk increase, even after a record $7.1 billion weekly withdrawal from junk-bond funds.