Ebbing Tide

The Incredible Shrinking Junk-Bond Market

Investors may express skepticism about value, but they continue to pay higher and higher prices.
Photographer: Dan Kitwood/Getty Images

It’s hard to get excited by the U.S. junk-bond market.

The debt isn’t yielding much on a historical basis. The companies that sell it have become less creditworthy, adding debt faster than they’ve increased profits. And the U.S. economy, while relatively healthy, has shown signs of vulnerability.

Low and Lower

Investors can't get too excited about junk bonds that are yielding so little relative to history

Source: Bloomberg

And yet speculative-grade bonds have performed remarkably well this year, especially given their longer-term, solid run. They've returned 4.8 percent in 2017, on pace for a 12 percent annual gain.

There are some obvious reasons for the good performance. Benchmark borrowing costs are still low, meaning that there’s still appetite for higher-yielding securities. And corporate profits have been pretty upbeat of late.

But another strong factor is underpinning the market’s strength: The total amount of such debt is shrinking. Companies are paying down the debt they owe faster than they sell new debt. Total junk-bond issuance in May was the lowest for the month since 2012, according to data compiled by Bloomberg.

On the Wane

Total new U.S. high-yield bond sales were the lowest in May for the month since 2012

Source: Bloomberg

The face value of total bonds in the Bank of America Merrill Lynch U.S. High Yield Index has fallen to $1.28 trillion, near the lowest level since 2014 and down $100 billion since its March 2016 peak.

Shrinking Pool

The total amount of dollar-denominated junk bonds has been contracting in recent months

Source: BofA Merrill Lynch index data

This is important. It means that junk-debt investors can’t find enough new bonds to buy with the steady stream of cash that they’re receiving from their investments. Instead, they must decide whether to allocate their money toward some other asset class or simply pay higher prices for existing notes.

So junk-debt yields continue to fall, even relative to a comparable measure for the S&P 500 stock index. And even as a growing number of investors express skepticism about the value in these notes, many continue to buy them at higher and higher prices.

Closing the Gap

U.S. junk-bond yields have been contracting at a faster pace than a similar measure for stocks

Source: Bloomberg Barclays US Corporate High Yield Yield to Worst index; Bloomberg data

Just think, Hertz Global Holdings Inc., the auto-rental company that has posted disappointing earnings and faces a deteriorating used-car market, just this week raised $1.25 billion of junk-rated debt, a deal that was increased in size because of substantial demand. Investors aren't being entirely careless; they demanded a hefty yield of 7.625 percent on five-year notes, or more than 2 percentage points more than similarly rated debt.

Still, the appetite for these bonds given the gloomy outlook for both Hertz and the auto industry shows just how much money there is aimed at this market.

More than likely the high-yield bond rally will temper a bit or even stall. But it's hard to see an imminent crash, especially as the size of outstanding debt declines and existing notes keep paying down, leaving cash-flush investors with limited places to put their money. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lisa Abramowicz in New York at labramowicz@bloomberg.net

    To contact the editor responsible for this story:
    Daniel Niemi at dniemi1@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.