The news du jour over the next few weeks will be about whether the Federal Reserve (“Fed”) will raise interest rates. In anticipation of the Fed’s meeting, the bond market is already making adjustments to bond prices – especially in the corporate bond market. In our last bond market update in June, we discussed what a rise in interest rates would mean for bonds – Please click here to read that market update.

One segment of the corporate bond market that is showing distress is the high yield (“junk”) bond market. We believe that junk bonds make sense in a bond portfolio over the long run. However, there are times to overweight junk bonds (early 2009) and times to underweight them (today). In the history of our firm, we have always held a position in junk bonds. That is, except for today. In our opinion, companies have issued too many junk bonds with little or no covenants protecting bond holders. The chart below clearly illustrates the difficulty the junk bond market has had since our last bond market update.

What does this mean for portfolios?

As mentioned in our last bond market update, the time to make moves is ahead of the market. Even with the recent junk bond market correction, we do not believe it is time to jump back in to junk bonds. The reason for this is the lack of liquidity in that market. Almost all of the fixed income managers we talk to have mentioned that liquidity is a major concern, especially in the corporate sector. Because of that, we believe junk bonds will continue to experience downward pricing pressure for some time.