Perhaps a lot of desperate retirees are reaching for yield in this low interest rate environment, or maybe the pressure for yield is just reflecting nervous investors’ desire for cash in pocket. In any case, buyers have now started to chase even high-yield bonds without restraint. According to a Citigroup report, “Yields on high-yield, high-risk debt have narrowed by 80 basis points relative to benchmark rates in the past two weeks.” In the depths of the bear market early this year, there was tremendous investor demand for high quality bonds, particularly U.S. Treasurys. Since that time, the iShares Barclays 20+ Year Treasury portfolio (TLT) has dropped more than 15% in price.
I suppose when so much of the flow of mutual fund money is being directed into bond funds, a certain amount of it is going to flow to high yield, where it may compress credit spreads. Still, the recent action in high yield bonds prompted the Citigroup analysts to write, “We understand investors are not supposed to fight the cash, but this is starting to become a bit ridiculous.”
If you believe the Modern Portfolio Theory fairy tale, you would have to insist that this is just a rational response on the part of investors to a low interest rate environment. If you believe the Dalbar data, however, you might think instead that panicked or desperate investors are reacting emotionally and just setting themselves up for another beatdown. I have no idea how interest rates and credit issues will play out, but it might make sense to go systematically with the strongest trends instead of with the crowd—and the strongest trends right now are in equities, not in bonds.
