NEW YORK — The stock market isn’t the only place that’s been signaling jitters among investors. The $2.3 trillion market for risky U.S. corporate debt has also been under pressure.
A five-year rally in junk bonds abruptly stalled last month. As with other higher-risk investments, investors have pulled back mainly because they worry about the end of the Federal Reserve’s policy of near-zero interest rates. Investors expect the central bank to raise rates sometime next year, and that means the value of bonds currently held in portfolios will fall.
Junk, or high-yield, bonds are sold by companies with relatively high debt in comparison to their income. If yields on safer bonds like Treasurys were to climb, they would draw more investor interest. Companies selling junk bonds would then have to increase their yields to compensate investors for the higher risk. Doing so would diminish the value of junk bonds currently in circulation.
In July, those concerns hit the market, leaving junk bond investors with a 1.3 percent loss for the month. It was the worst monthly performance since June, 2013.
Junk-bond yields have fallen so far that many investors now feel the risks outweigh the potential return. Five years ago, the average junk bond yielded 11.5 percent.
By June, the yield had dropped to a record low of 4.83 percent, according to data from the investment bank Barclays.
There is often some role for high-yield bonds in investors’ portfolios, but “there’s a time to dial it up, and a time to dial it down,” says Darrell Cronk, deputy chief investment officer at Wells Fargo Wealth Management. “Now is a time to dial it down.”
Mr. Cronk says junk bonds might continue to slump as the economy improves and investors push up Treasury yields in anticipation of the Fed nearing its first interest rate increase since May, 2006.
The market for risky bonds has become more mainstream since the 1980s, when trading was dominated by Michael Milken, the junk-bond financier, and his now-defunct firm Drexel Burnham Lambert. In those days, the market made headlines for helping fund takeovers of companies such as RJR Nabisco Inc. Mr. Milken’s reign as the king of junk bonds ended in 1989, when he pleaded guilty to securities fraud, defrauding a mutual fund and other felonies.