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Junk bond mutual funds and ETFs recently saw a $5 billion weekly inflow – the biggest surge on record. Is the turnaround for junk bonds sustainable, or is it a trap?
It seems the market risk switch has flipped from “risk-off” and back into the “risk-on” position. But the recovery of junk bond prices is just one of the benefactors: Just in the past few trading days, oil crossed $40 for the first time in 2016, the Dow Jones Industrial Average turned positive for year and Asian stocks are also in the black for 2016.
But how long will the risk-on mode remain in effect? Is now a good time to buy shares of junk bonds and high-yield bond funds?
Junk Bonds and Oil Prices
Most of the average to above-average high-yield bond funds have done much better than the broader bond market over the past few weeks. For example, Pimco High Yield (PHDAX) is up 5% in the last month, while the Barclays Aggregate Bond Index is struggling to remain above zero for the same time frame.
Other than the power of positive investor sentiment, one key factor of support for junk bonds is the stabilization of oil. While there are doubts about the reality of the “coupling” of stocks and oil, there is more of a correlation between junk bonds and oil.
For example, some of the larger oil companies like the troubled Petrobas (NYSE: PBR) financed much of their operations with debt when times were good and they went further in debt more recently in order to survive the plunge in oil prices. Although a relief in crude prices doesn’t solve the challenges of oil companies, it does support a bounce in high-yield bonds, especially those that have a connection to oil companies, because fears of default have subsided (for now).
Should You Buy, Sell or Hold Junk Bonds?
If you hold high-yield bond funds, the question of buying, selling or holding them now really should be based upon your investment objectives, rather than timing strategies.
For example, if your time horizon is more than 10 years, you can consider yourself a long-term investor and holding funds with junk bonds in them is not a bad idea now, especially if the funds are part of a diversified portfolio that might include other bond funds, such as a total bond market index fund.
But if your holding period is less than three years, and you don’t have high tolerance for risk, high-yield bond funds probably weren’t an ideal choice for your purposes in the first place. Therefore selling now at decent prices could be a valid consideration.
If you currently hold individual bond securities, it’s likely that they serve an income purpose in your portfolio and selling them now probably doesn’t make sense unless you believe the issuing company is in danger of default before your junk bonds mature.
The best perspective is to remain focused on the big picture of your savings and investment goals and to not allow the short-term whims of the market to deter you from your plans and strategies.
Kent Thune is the owner of an investment advisory firm in Hilton Head Island, S.C. He personally does not hold any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.
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