Monday, April 20, 2009 1 comments ++[ CLICK TO COMMENT ]++

Historical junk bond default rates

Felix Salmon, who now blogs for Reuters, managed to get some information on junk bonds (aka high-yield bonds, aka speculative-grade bonds). Since my interest, if I were to invest any bonds, is with junk bonds, I have always been interested in historical default rates. The following chart (from Moody's I believe) plots defaults on junk bonds since 1920:

Moody's is projecting defaults that are on par with the rates during the Great Depression. In the worst case, the default rates are supposed to exceed those during the 30's. However, the business environment is radically different now. The junk bond market only took off in the 80's. Furthermore, there is higher corporate leverage now than in the 30's. So, high defaults don't necessarily mean that we are looking at a depression.

What does all this mean for bond investors? Well, here is how I look at it. The yields on junk bonds are high (15% to 20% or so) but the risk of default is extremely high as well. I don't really think one can say the market is necessarily mispricing these bonds (unless you think defaults will end up being much lower.) It may be the case that some specific bonds are mispriced but the market as a whole is not necessarily cheap.

My impression of junk bonds is similar to the stock market as a whole. That is, valuations are lower than at any point in the last 20+ years but that doesn't mean it is very cheap. The P/E ratio for the stock market may look low, and the yield for junk bonds may look high, but this is not exactly cheap if you have some concern about defaults, losses, contracting profit margins, and so forth. You can go and invest in, say, HYG, the junk bond ETF from iShares yielding about 15%, and may still lose money.


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