In January, we warned you that bond investors were getting greedy. In an effort to earn higher yields on their bond investments, they were piling into risky junk bonds.
We saw this by looking at the “risk premium.” This is the difference in yield between BB-rated junk bonds and “risk-free” U.S. Treasurys.
The risk premium hadn’t been so low since 2007. It widened when the debt bubble was pricked the following year, in 2008.
When the risk premium widens, yields typically go up. And when yields go up, bond prices go down… causing bond investors to lose money.
We didn’t know when the market would burn junk bond investors, but we knew it would be soon. With the risk premium near all-time lows and our crash flag flying, it was only a matter of time.
As we put it then: “When risk becomes apparent again in the markets, the gap [between junk bonds and Treasurys] will widen.”
And as you can see in the chart below, that’s exactly what’s happening now.
Since January’s warning, the risk premium on BB-rated junk bonds has gone up from 2% to 8%, wrecking the junk bond market.
The junk bond market – measured by iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the largest junk bond ETF – has fallen 16.4%.
The now-elevated yields on these bonds may look attractive. But we urge readers to remain wary of this risky market.
As you can see from the chart above, the risk premium still hasn’t caught up to financial crisis levels. That means it could run higher still… and lead to even more losses for junk bond investors.