High Yield Corporates Or The S&P 500?

Stocks are cheap versus high-yield corporate bonds, but our U.S. Investment Strategy service makes a case for favoring the latter.

High Yield Corporate Or Stocks

T otal returns in the high-yield bond sector have kept up with the S&P 500 over the past three years, with far less volatility. One of the reasons why high yield has performed so well versus equities is the inverse relationship between spreads and the level of Treasury yields.

When spreads widened, the Treasury curve shifted lower, mitigating the effect on the level of junk yields. Conversely, when the economy appeared to be on better footing, Treasury yields rose but spreads narrowed. This positive dynamic admittedly will not be as pronounced going forward now that junk yields have dropped to such a low level. Nonetheless, high yield is still attractive, especially in a low-but-positive growth world.

Also, junk bond returns typically match or outperform equities during periods when corporate health is improving – although, more recently there are some worrying developments on this front.  In terms of valuation, junk bonds are expensive relative to equities, but this has been the case for two years. The wide yield gap represents an elevated equity risk premium that we do not believe will quickly disappear.

Bottom line: The latest bout of reflation from the Fed should lift all risk assets, but lower volatility in the bond market is an important reason to favor high-yield bonds for now with the exception of the lowest credit tiers (CCC and below).

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BCA Research is a world leading provider of independent investment research. Since 1949, the firm has provided its clients with leading-edge analysis and forecasts of the major financial markets, with clear and focused investment strategy recommendations and backed by countless proprietary models and leading indicators. Asset class coverage includes equities, fixed income, currencies, real estate, commodities and geopolitics. The firm provides its services to financial professionals across six continents, through a wide range of products, services, and meetings. BCA maintains a head office in Montreal, with local offices in New York, Los Angeles, London, Hong Kong, Sydney, and Buenos Aires. Not yet a client of BCA? Take a short trial to our research.