Junk Bonds: No One Expects Volatility… Here’s Why YOU Should

Prolonged periods of financial complacency are generally followed by a volatility that seems to appear out of nowhere.

This applies to any financial market.

For instance, the October 2017 Elliott Wave Financial Forecast noted:

Investor optimism and complacency continue to set record extremes.

Saying that volatility erupted just a few months later is an understatement.

On Feb. 5 of this year, the DJIA closed down 1,175 points, by far the single biggest point loss in the index's history. Just three days later, the DJIA plunged 1,033 points, marking a decline of more than 10% from the all-time high on Jan. 26.

Now we're seeing an extreme complacency in another financial market: junk bonds.

For example, on July 23, this was the headline on the website of a nearly $400 billion asset management firm:

Four Factors that Favor High Yield Bonds

The August Elliott Wave Financial Forecast highlights the epic display of investors' complacency toward risk with this chart and commentary:

This chart shows the percentage return for U.S. Corporate CCC-rated junk bonds, the debt of companies with some of the weakest balance sheets, versus the return for U.S. Corporate investment grade debt.... The year-to-date return on CCC-rated bonds is 4.46% versus a negative 2.71% return for investment grade debt. Some observers say the outsized returns for junk debt is because of a dearth of bonds that offer investors the potential for high yields. But the supply of bonds is only half the equation. Every transaction must include a buyer, someone willing to place their money at risk by purchasing the asset. The returns in 2018 indicate there is high demand for these extra-junky bonds.

This is notable considering what Standard and Poor's recently said:

[The issuer of CCC-rated bonds is] currently vulnerable, and dependent upon favorable business, financial, and economic conditions to meet its financial commitments.

In other words, the next economic downturn could spell big trouble for investors in junk bonds.

Remember, in financial markets, a historic volatility can seem to arrive out of nowhere.

It's best to prepare now, and EWI's analysis and forecasts for the U.S. stock market, economy -- and yes, bond markets, as well -- will help you to do just that.