The S&P 500 recently crossed into new territory, making all-time highs above 3,000. While the U.S. economy seems relatively stable, it may not be U.S. earnings growth that is driving the outperformance.
Falling interest rates and bond yields around the world are leaving investors with few viable options in the bind market. These falling yields are now entering extreme and uncharted territory, with even some junk-rated corporate bond yields now dropping below 0%.
Europe Goes Negative
The Wall Street Journal recently reported the percent of European high-yield corporate bonds that are now paying negative yields is spiking. Historically, companies with lower credit ratings and more financial risks are forced to offer higher yields on their bonds to incentivize investors. With yields falling so low across the board in Europe, investors are now essentially paying interest to invest in a handful of junk-rated corporate bonds.
Bank of America reports that the percentage of BB-rated European corporate bonds paying a negative yield has jumped from 0.225% at the end of May to 1.5% at the end of June. The firm says 14 different companies now have junk-rated bonds rated BB or lower that have negative yields. Collectively, those bonds represent more than $3 billion of junk debt.
The percentage of BBB-rated European bonds paying a negative yield is also spiking. A BBB rating is the lowest level of corporate debt still considered investment-grade. Roughly 12.4% of BBB-rated European corporate bonds now have negative yields, according to Bank of America. That percentage is up from 0.02% at the end of January.
Why Buy Negative-Yield Bonds?
It may seem counterintuitive for investors to buy bonds with negative interest rates. But the unfortunate fact is for Eurozone investors, there are few safe havens for cash at the moment.
Yields on 10-year government bonds in France and Sweden recently dropped below 0%, following in the footsteps of Germany and Japan. In Denmark, a handful of financial institutions are even offering negative-yield mortgages to homebuyers. In fact, global negative-yield debt has now ballooned to an all-time high of $12.5 trillion, double where it was in December.
Even in the U.S., yields on 10-year Treasury bonds recently dipped below 2%. While that yield is relatively high, it’s essentially zero when adjusted for roughly 2% inflation.
Some bond investors buying negative-yielding junk bonds are likely simply betting that yields will fall even further into negative territory. Bond prices and yields are inversely correlated, so bonds increase in value as yields fall.
That correlation can be seen in the performance of the iShares iBoxx $ High Yid Corp Bond (NYSE: HYG), which is up 7.1% year to date. The ISHARES INC/INTL HIGH YIELD BD (BATS: HYXU), which has roughly a 90% exposure to Europe, is also up 5.8% this year.
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