Put Junk in the Trunk

04/27/2012 8:15 am EST

Focus: INCOME

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

One thing that is certain about an economic recovery mode is that junk bonds will be back in vogue, write Mary Anne and Pamela Aden of The Aden Forecast.

Policymakers have done a good job mixing debt restructuring with injections of cash to keep demand growing. Investment guru and colleague Ray Dalio says, “the risk of chaos has been reduced,” and things are calming down.

But the trend is still down regarding interest rates. It’s been a tough balancing act...and considering the big picture circumstances, which we discussed last month, so far so good. But we have to stay cautious and watch the markets.

The ten-year yield, for instance, could still rise further before it’s overbought. But will the rise be enough to turn the trend around? We don’t think so, at least not yet.

More likely, interest rates will probably bounce around like they’ve been doing and remain volatile for a while. For now, the major trend is still up for bond prices and it’s down for interest rates.

And even though the 30 year yield may be bottoming, if it stays below 3.75%, the major trend will stay down. As long as that’s the case, we recommend keeping the long-term government bonds you have, but don’t buy new positions at this time.

Many of you have asked us about how to get higher yields. With rates so low and the economy rather uncertain, risk seems high almost everywhere. And as most of you know, for the past few years high yields have been a thing of the past.

Our dear friend and well respected analyst Steve Sjuggerud believes high-yield (or junk) bonds are now at an ideal buying spot, and he provides evidence to back this up. We’ve known him a long time and value his views. He takes his work very seriously, so we wanted to pass this on…

High-yield bonds are rated below BBB and they’re considered speculative. But there are times, usually when a recovery gets underway, when they’re a good investment and do well.

As Steve points out, junk bonds are currently yielding 8%. That’s a huge 6% more than Treasuries. This happened in 1991, 2002, and 2009, and each time, junk bonds surged. Plus, the default rate is now only 1.5%, which is extremely low.

In other words, risk is low and the upside looks good. He likes the iShares High-Yield Corporate Bond Fund (HYG) and we agree. It’s currently paying 7.26% interest.

As you know, this is an area we don’t normally venture into. But after checking it out, we feel this provides a good opportunity to collect a higher yield in the year ahead, using a portion of your bond portfolio. It’s especially attractive considering it’s one of the few high-yield alternatives currently available.

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