6 Things to Keep in Mind About Junk Bonds in Q4 and Into 2017

Some conservative investors might cringe when they hear the term “junk bonds.” Investors with a higher appetite for risk may start to smile, looking forward to those fat juicy yields way above what they can earn in most dividend stocks or Treasury yields. With 2016 coming to a close, and with the presidential election making most of the public neurotic, investors need to consider several things about yields in general — particularly in junk bonds.

24/7 Wall St. has issued a primer on what investors need to be considering at this time for junk bonds.

The Federal Reserve seems dead-set on raising interest rates. December looks most likely as the “when,” and a 0.50% to 0.75% target rate is most likely. We tracked multiple Fed presidents making comments this past week, jawboning about the need to hike rates.

S&P releases its speculative-grade composite spread each day. Quite simply, this is the average spread that all junk bonds have to pay over Treasury yields to get funding. That spread was 535 basis points at the end of the week of October 14. While this is actually a tad wider than recent days, the reality is that this is rather stable for a junk bond market. During even mild panic selling that spread can hit 700 basis points — or it can get even wider.

It looks like defaults have likely peaked. Fitch Ratings said this last week and predicted that the default rate of high-yield issuers could drop in half in 2017. That would be monumental, with the default rate of 5% or 6% in 2016 dropping to 3% in 2017. That might bring solid junk bond returns in 2017 even if Treasury yields tick higher on a slow basis.

Is the end of negative interest rates coming? Earlier in October we pointed out that rates were not just rising in the United States. Sovereign debt was still negative in some of Europe and Japan, but negative rates already may have peaked, as long as the economy does not roll back over.

The quality of stock dividend hikes will matter more and more as 2017 gets closer. When investors decide whether to chase high-yield bonds or go for stocks, they will focus on stocks that have raised dividends for many years, and ones that can keep raising their dividends for years. 24/7 Wall St. listed four Dow stocks that have raised dividends for 50 years and that can continue in the years ahead. Through time, these can create serious rivalries for junk bond investors — and you are not likely to see any threats of defaults in players like that.

Please know what you own. It has just come back into the light that even conservative investors may own junk bonds. Flexibility in fund manager views and allowances in investment policies may let downgraded bonds stay in a portfolio, or a short-term junk bond can be allowed or a bond that a fund manager thinks should be investment grade is allowed. As always, caveat emptor!

This is perhaps far from a full story on what to look for in junk bonds as 2017 nears. Still, many investors need to understand where they want to be investing after this presidential election.

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