Banking

Industry Voice: Outlook May Favour High Yield Bonds Over Equities

The confluence of several factors—including tightening monetary and fiscal policies, geopolitical turmoil, and stubbornly high inflation—has created an environment in which the potential risks for equities outweigh the potential rewards in the near to medium term. 

For investors seeking alternatives, we believe that high yield bonds currently may offer a compelling yield advantage relative to equities. In particular, a comparison against the forward equity earnings yield, which accounts for a company’s entire earnings and not just the portion paid out in dividends, shows a significant yield advantage for global high yield (Figure 1). Further, while equity earnings may be revised downward if economic growth weakens, a potential added advantage for high yield bond investors is that cash flows are unlikely to be affected unless a company defaults. 

High Yield Advantage Over Equities

(Fig. 1) High yield bonds could offer a more attractive risk/reward trade-off in the near term

Past performance is not a reliable indicator of future performance.
Sources: Bloomberg Index Services Limited and MSCI. T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. See Additional Disclosures.
*Yield to worst is a measure of the lowest possible yield that can be received on a bond with an early retirement provision.
† Forward earnings yield is calculated by dividing the expected earnings per share (EPS) in the next twelve months by the current share price.
‡ Forward dividend yield is the percentage of a company’s share price that is expected to be paid out in dividends over the next year.

Although we recognize that credit risk is a valid concern, credit quality in the high yield universe has steadily improved, on average, since the end of the 2008-2009 global financial crisis. Over the past 15 years, the share of high yield bond issuers in the Credit Suisse High Yield Index rated higher than single B—levels typically deemed less susceptible to default risk—has increased from 37% to 59%.  

 

 

This post was funded by T. Rowe Price

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