Have High Yield Bond Funds Just Begun a Major Uptrend

Summary: The High Yield Corporate Bond (HYCB) sector has recently undergone a bear market comparable to the 1987-1990 and 1994 bond bear markets. After bottoming in December 2000, we believe the HYCB market has begun a sustained recovery period that could produce annualized returns of 17% or better over the next 2-3 years.

Bear markets – sustained downtrends –
set the stage for bull markets.

This alternation of bull markets and bear markets happens in High Yield bonds just as it does in the stock market. As shown in Chart 1, for example, the past 13 years have seen three bear markets and two bull markets in High Yield bonds.

As Chart 1 starts out, High Yield bonds had a nasty bear market from 1987-1990. They then recovered and trended upward for the next three years, into early 1994. During that extended favorable environment, in 39 months Value Line Aggressive Income gained 86% (rise in share value, plus dividends), while Northeast Investors Trust gained 98%, Fidelity Advisor High Yield gained 117%, and MAS High Yield gained 136%. This was a very productive period for junk bond funds! (See Chart 5 in the Appendix.)

Similarly, after the 1994 bond bear market, High Yield bonds trended upward for the next 3 1/2 years (see Charts 1 and 2). From December 1994 through mid-May of 1998, Value Line Aggressive Income gained 72% (again, this return reflects the powerful combination of a sustained rise in share value, plus dividends), Northeast Investors Trust gained 74%, Mainstay High Yield gained 67%, Fidelity Advisor High Yield gained 66%, and MAS High Yield gained 73%. (See Chart 6 in the Appendix.)

Those two periods of recovery and sustained uptrends are marked on Chart 1 as "bull markets". As those periods demonstrate, during favorable environments – i.e., recoveries from bear markets – the best-managed HYCB funds can trend upward quite steadily at annual rates of 17% or better for 2-3 years. So as you can see, it can be very profitable to shift money into well-managed HYCB funds during the early weeks of such an extended uptrend!

It Appears that HYCB Funds Made an Important Bottom in DECEMBER, and that a New Uptrend is Underway.

Chart 2 below is a closeup of the last 5.5 years from Chart 1, highlighting that dividend yields are much more attractive than they were at the bull market peak two years ago.

And as shown in the update chart below, after declining from early September into early December (Sierra clients were safe in money-market during most of that episode), High Yield bonds have recently turned up strongly, resulting in "buy" signals under Sierra's Defensive Timing discipline.

With dividend yields now much higher than Treasuries and CD's, we believe that the HYCB market is undervalued and beginning a sustained recovery period that could again produce annualized returns of 17% or better over the next two or three years – with much less volatility than a stock fund.

ConCLUsIONS

The foregoing should not imply that Sierra knows how to sell on the top day, or buy on the bottom day – we do not; we always react to trend reversals after the top or bottom. Nor do the foregoing figures reflect Sierra's quarterly fees. But this data does demonstrate that bull markets in the HYCB sector can last for 2-3 years or more, and that the expertly-managed HYCB funds selected by Sierra for our managed accounts can deliver very productive gains during the extensive uptrends that occur after bear markets.

Although there can be no assurance that our expectations will be met, we believe that Sierra's High Yield Bond Program – in which we diversify each client account among four or five well-managed HYCB funds – will perform very well in the months ahead, and will average 11% or better (after all fees) over the next several years. Meantime, your downside risk is limited to 3% or less, with Sierra's daily monitoring and Defensive Timing.

Call us for a personal meeting or send us an email at Info@SierraInvestment.com for more information.

Appendix - supplemental charts:

Chart 4: When its substantial dividends are included, this High Yield bond fund chart tracks the
Total Return of the fund – but masks the bull market and bear market phases in the underlying High Yield bond values disclosed by Chart 1 in the main article.

Chart 5: The bull market of 1990-1994 resulted in impressive and sustained gains in such excellent HYCB funds as Fidelity Advisor High Yield and MAS High Yield – at annualized rates of 17% or better.

Chart 6: The bull market of 1995-1998 also resulted in sustained strong gains in well-managed HYCB funds such as Northeast Investors Trust and Value Line Aggressive Income – again at annualized rates of 17% or better.