With yields close to 9%, junk bonds currently offer excellent value, according to our Global Investment Strategy service.
There are a number of factors that argue in favor of slightly overweighting corporate bonds, especially high yield bonds. The U.S. corporate sector is underleveraged, has plenty of cash and has sustained a long period of solid profit growth. The default rate should be contained even if the U.S. economy goes into a low-grade recession. Also note that since 2008, high-yield bonds have delivered superior returns compared to the S&P 500, but with much lower price volatility. Longer term, the expected risk-adjusted return for junk bonds looks better than that for common stocks. For instance, the expected long-term return for the S&P 500 should be around 6.5% (consisting of 2% dividend yields and about 4-4.5% nominal GDP growth) which is in line with prospective junk bond returns after adjusting for expected defaults. Overall, investors in U.S. assets should skew their risk exposure towards corporate bonds, especially high-yield bonds, at the expense of equities (which we recommend being at benchmark allocation).
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