It should be based on the premium an investor can get buying high-yield debt versus Treasury notes. An astute investor will buy when the spread is wider and sell when the spread narrows.
That spread is the lowest it has been since the middle of 2014, currently sitting under 4%. The St. Louis branch of the Federal Reserve has all the details.
We only need to look back to mid-2014 to see the potential downfall in buying junk bonds when the credit spread is this low. JNK traded at just under $42 per share in June of that year. In mid-2015, shares had fallen to $38 each before eventually falling to $32 each in February, 2016. That’s a decline of 24% from peak to trough. HYG saw similar losses.
The opposite thing happened in February 2016. The junk debt premium was flirting with 9%, which was the highest level in the preceding five years. That was the buy signal.
The Bottom Line on Junk Bonds
Historically, the trend has been pretty simple. When the junk bond premium falls to 4%, it has not been a good time to buy junk debt ETFs. It wasn’t in 2014, and it sure wasn’t in between 2005 and 2008, when the spread was under 3%.
Today is not the time to buy.
Investors should wait until the junk bond spread goes much higher, ideally to the 6% to 7% range, or perhaps even higher. If history repeats itself — which it often does when investing — an investor who gets into JNK and HYG at that range is likely to reap attractive capital gains along with a great income stream.