Although most of the investing public's attention is still focused on volatility in the U.S. stock market and fears of a further correction, the bond market has been filled with its fair share of drama.
High-yield bond ETFs like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and SPDR Barclays High Yield Bond ETF(JNK) have fallen at least twice as much as the S&P 500 over the past three months — down 3.6% and 4.7%, respectively, compared to 1.8% for the S&P 500. They are the two largest high-yield bond ETFs; HYG has nearly $13 billion in assets while JNK has $9 billion.
Even more alarming is the rising level of individual high-yield bonds trading at distressed prices. Almost 15.7% of the 1,720 bonds rated below investment grade were in distress as of mid-September, according to Standard & Poor's Ratings Services. This figure represents the largest number of speculative high-yield bonds at crisis levels in four years.
Bonds from debt-saddled companies inside commodity-linked sectors like basic materials and mining are contributing to the jump in distress ratios, which will likely lead to debt defaults.
Any corporate bonds with a credit rating below BBB− are typically categorized as high-yield or junk bonds because borrowers have an unestablished or shaky credit history.
Although the risk of investing in high-yield bonds has always existed, many investors have ignored these warnings over the past several years.
Due to depressed interest rates driven by the Federal Reserve's zero interest rate policy that dates back to 2008, yield-thirsty investors shifted money into hig- yield bonds hoping to collect more income. But while high-yield bonds pay higher income compared to investment-grade debt, these types of speculative bonds are loaded with credit risk.
