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High Yield Bond Bubble? Not so Fast Says Bespoke’s Hickey


Despite a rally that took stocks 5% higher, investors took a total of $16.3 billion out of stock funds and added twice that much to bond funds in the 6 weeks prior to August 8th. It's just the latest data point in a bond fad that has led to $43 billion being invested in junk bonds so far this year. The trend shows no signs of abating despite unimpressive yields of 6.89% for high yield (read: junk) bonds.

Inevitably the public's lust for yield has led to much fear of a "bubble" forming in bonds. Paul Hickey, co-founder of Bespoke Investment Group says the fund flows may be huge but debt pricing isn't historically unusual.

"What you have to measure in fixed income products is their spread versus the risk free asset, which is Treasuries," notes Hickey in the attached video. "We're at a little under 600 basis points right now; the average going back to 1998 is 600. So we're about 10 basis points below the average."

For those not familiar with bond lingo, each basis point equals 1/100th of 1%. On average high yield debt pays 5.99% more than Treasuries. Right now that spread is 5.89%. Unless you're a bond trader the difference between current prices and the average yield since 1998 is all but irrelevant. As Hickey puts it, "Ten basis points is nothing; you see that in a day."

The point is that high yield is only as inflated as the bond market as a whole. Pricing through the bond spectrum isn't historically distorted. Junk is still being properly priced by the market relative to risk-free assets. By what should be the definition of a "bubble," there isn't one in Junk.

Thanks to an aging population and lunatic equity markets, a growing number of investors are looking for yield. Only time will tell if going into bonds here is the right decision. But Hickey says those crying "bubble" should be complaining about Treasuries, not junk bonds.