Monday, January 31, 2005

High Yield Bond Funds… Time to Sell This Investment
By Dr. Steve Sjuggerud, Advisory Panelist, Investment U

Yesterday’s weeds are today being priced as flowers.”Warren Buffett said that nearly a year ago. He was talking about high yield bond funds and it’s only gotten worse

As of today, those high yield bond fund “weeds” of a year ago are now priced like Dutch tulips in the 17th century, which were bid up to irrational heights only to come crashing down.

High yield bond funds (or “junk” bonds, as they’re commonly called) are now at irrational heights. Unfortunately for investors holding them, they will likely follow the tulips.

If you own any high yield bonds now (or any particularly risky type of bond, like emerging markets bonds), it is time to sell. Get out now.

Here’s the story

The Rule for When to Buy High Yield Bond Funds, and When to Sell

“When the spread is high, it’s time to buy,” I wrote in the December 2002 issue of my newsletter True Wealth. And boy the spread was wide. At the time, U.S. government bonds were paying 3.75%, and high yield bond funds were paying 10 full percentage points more than that. So we bought.

The trade turned out fantastically True Wealth readers made approximately 40% in a year – in bonds!

“When the spread is low, it’s time to go.” And right now, high yield bonds only pay 3% above Treasury bonds. It’s time to go.

Now, things are exactly the opposite of late 2002. The rule is: Over the last 20 years, junk has typically paid about 5 percentage points above whatever Treasury bonds are paying. In late 1990 and late 2002, high yield bond funds paid a full 10 percentage points above Treasury bonds. Those were fantastic times to buy. Not now.