Junk bonds had an OK 2021 and should do even better this year, in a par with stocks, which have been breaking records. So says Northern Trust Asset Management, which expects a 9% return for high yield for 2022.
“We expect high-yield returns to rival those of equity markets,” the firm said in a report. The analysts’ point is that junk will boost its gains, while stocks will decelerate.
Last year, junk bonds rose around 4%, as all the action centered on stocks, with the S&P 500 gaining almost 27%. But Northern Trust expects the stock market, after its long ride since March 2020, to slow its advance and increase by high single digits this year. Many have forecast that equities are overdue for a slowdown in their torrid appreciation.
While popular wisdom contends junk always trails stocks, the report declared that “high yield has outperformed US equities during up markets nine of the last 30 years.” That is, one-third of the time. The firm added that this junk return will come “with a lower risk profile” than stocks have.
Junk issuers these days have solid fundamentals, which have led to relatively narrow credit spreads to comparable Treasurys, Northern Trust noted. The spread now is just over 3 percentage points, which is low compared with the gap that prevailed even before the pandemic, when the economy was doing well with low inflation. At the start of 2019, the spread was 5.4 points.
Interest rate hikes, which appear to be coming, have historically hurt junk less then other types of bonds, studies have shown. The expected rate boosts are hardly large, and thus continued low interest from other fixed income should enhance junk’s allure, in the firm’s view.
“We prefer credit risk over interest rate risk,” the report said. And, certainly, with a very small default rate in 2021, of 0.4%, high yield now has the profile of a low-risk investment. The long-term default average for junk is 3.5%.
This year, junk should benefit from further spread tightening, which would help boost its prices. New high-yield paper had a robust issuance in 2021, of $464 billion, the most in at least 10 years, according to S&P Global Market Intelligence.
Indeed, half of the junk market is rated BB, the level right below investment grade. Energy was the best returning junk category last year, with low double digits, and analysts believe it will continue to be in the new year.