Overweight U.S. High Yield Bonds (BCA)

U.S. high yield bonds represent an opportunity for investors to benefit from a resurgence in the "risk on" trade, while getting some downside protection against the current economic softness, says BCA Research, this week.

Relative to equities, junk bonds are expensive, however it is representative of a lasting trend of raised equity risk premium that BCA says is not likely to fade away anytime soon. In absolute terms, corporate bond valuations remain attractive, as well as in relation to Treasurys, in the context of minimal default risk, and considering the recent backup in spreads.

The health of corporate balance sheets is also sustaining improvement, and the Fed's low interest rate environment has investors seeking yield for the foreseeable future, and could most likely result in yield spreads being pushed well into overbought territory, before this rally comes to an end.

Junk bonds have performed superbly since the beginning of the rally in March 2009, and BCA believes the favourable conditions enabling junk bond investors to profit still have some way to go.

The inverse relationship between junk spreads and Treasury yields is one of the important reasons high yield has outperformed during the most recent "risk off" period. That is, the Treasury curve shifted lower while spreads widened, and this had offset effects on on junk yield levels.

Should the opposite conditions occur, in the event the economy has a stronger second half, Treasury yields should increase, however, spreads should narrow even more, according to BCA.

Given the uncertain economic outlook, this makes the junk bond index's running yield attractive; BCA's bottom line call - Upgrade high-yield back to overweight.

Source: BCA Research - Daily Insights

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