Investors should be wary of US junk bond rout

US funds investing in high-yield debt have been hit by huge outflows in recent weeks

The latest data from America show investors are dumping riskier debt faster than during the financial crisis in 2008. The money is rushing to safe havens such as US government bonds and gold. The staggering shift in investment strategy marks a reversal of the chase for returns that has been in place for five years.

 In the past, the junk bond market has only really been used by professional investors or those with a higher risk appetite. However, all that changed from 2009 onwards, when central banks destroyed investors’ returns by reducing borrowing rates to almost zero and flooding the global economy with money. 

A bubble forms when prices exceed the level that the underlying fundamentals can support. Investors desperate for returns have been blowing a bubble in the high-yield bond markets for five years.

The first is that it hints at a repricing of risk within the financial markets, something that has been notable by its absence for five years. When financial markets price risk incorrectly in the bond markets, they will also price risk incorrectly in the equity market. If the exodus from the bond markets is indeed an indication of mispricing returning to the bond markets, equity markets will follow shortly. 

 The flood of money coming out of the US high-yield bond market is only a tremor at the moment, but the financial markets have been so distorted by government meddling and unable to price risk correctly that it could have far- reaching consequences.

DYI