Not many asset classes finished 2018 on a high note. But the December pullback was particularly harsh for high-yield bonds. In fact, the group suffered its worst monthly performance in eight years.
Like most in this category, the SPDR High Yield Bond (NYSE: JNK) fund ended 2018 in negative territory with a loss of 3.3%. Despite being riskier than their investment-grade counterparts, annual declines are rare for high-yield bonds.
And they don't stay down for long. According to State Street, high-yield bonds have rebounded 29% on average in the calendar year following an annual decline. While I wouldn't bank on that large of a gain, I do believe this same pattern will hold in 2019.
As you may know, this group isn't particularly rate-sensitive. Like equities, it responds more to broad economic changes, which in turn influence the ability of corporate borrowers to repay their IOUs. Right now, most are meeting principal and interest payments in a timely manner.
According to Moody's, default rates on speculative-grade U.S. debt are projected to fall from 3.0% currently (already well below historical norms) to just 2.0% by September. Fitch has them pegged even lower at a microscopic 1.5%.
At the same time, issuance of new high-yield bonds has dried up over the past year. According to Reuters, proceeds from global corporate bond sales shrank 24% in 2018 to $1.3 trillion – the lowest volume since 2011. As with any asset, lower supply tends to exert upward pressure on prices. A few months ago, for example, Diamondback Energy (Nasdaq: FANG) was flooded with more than $2 billion of orders for a $500 million offering.
With these solid fundamentals as a backdrop, investors that fled last month have been returning.
Action to Take
Benign default rates, low issuance, favorable credit trends and reasonable spreads over comparable Treasuries all point in the right direction for high-yield bonds in 2019. That's why I continue to rate JNK a "Buy" after all is said and done.
It's been a key holding in our premium Daily Paycheck portfolio for years, delivering nearly 42% returns in the process. The capital gains are nice, sure, but remember we're talking about bonds here -- so income is our primary goal. That's why we have this fund tucked away in the Steady Income Generator section of our portfolio, which is reserved for some of the most reliable dividend payers around. And with a current yield of 5.6%, JNK is still worth a look for investors today.