High-yield bonds, sometimes junk bonds, are notorious for their susceptibility to default in times of market crisis, such as the Great Depression and the Great Recession. Numerous studies have demonstrated that the junk world economy is more susceptible to market stress than the investment-grade bond market.

High-Yield Bonds Performance through History

Risks of High Yield Bonds

This occurrence has a simple explanation. Chances for enterprises to obtain capital become increasingly few as the economy declines and competition for these scarce opportunities increases. Companies that accrue such debts also lose the resources necessary to repay them. As a result of these factors, more businesses encounter the worst-case scenario or file for bankruptcy whenever the market is volatile. The investing community is well aware of this. As a result, they start by selling the riskiest bonds in their portfolio, which is bad news for the most vulnerable corporations with the worst cash-to-debt ratio. As investor interest in high-yield bonds declines, issuers are forced to cut their bond yields to maintain investment levels. This is a textbook example of supply and demand in action.

As it is colloquially known, the junk bond market focuses mainly on the last 35-40 years. It has been said that the junk treasury has only been around for the past four decades, ever since the 1970s when such bonds first started to gain in popularity and new types of issuers appeared as an increasing number of businesses turned to them as a source of short-term financing.

The 1980s Savings and Loan Crisis

Junk bonds' rise to popularity has not been without its share of difficulties. The first major problem occurred in the 1980s, with the Savings and Loan Scandal. S&Ls had over during higher-yielding corporate bonds and engaged in much higher-risk activities, which contributed to a massive drop in the performance market junk bonds that lasted almost a decade into the 1990s.The junk world economy increased by almost 34% annually during the 1980s, from $billion in 1979 to $189 billion in 1989. The average junk bond yield this decade was 14.5%, and the average default rate was 2.2%, leading to a total market return on investment of roughly 13.75% per year.

Drexel Burnham went bankrupt in 1989 because of a political push led by Rudolph Giuliani and others who had commanded the commercial credit markets before introducing high-yield bonds. In a shift that lasted maybe just 24 hours, the demand for new junk bonds collapsed and did not recover for close to a year. As a result, high-yield market investors lost 4.4% in 1990, the first year the market had negative consequences in almost a decade.

The 2000-2002 "Dot Com" Crash

The "dot-com" bust of the early 1990s saw a significant decline in the high yield market as many companies that had relied on higher return bonds to fund their operations went bankrupt. Someone didn't poison the market, and dishonest savings and loan investors didn't cause this disaster. Instead, this crash occurred because investors couldn't stop buying into the hype around the Internet's supposedly limitless profit potential due to its access to international consumers. The market crashed due to investors gambling on concepts rather than proven strategies.

However, after this mistake was exposed, investors backed safer options, and the slightly elevated bond market swiftly recovered. The average market default rate from 2000 to 2002 was 9.2%, about four times greater than the rate from 1992 to 1999. In 2002, many defaults, including bankruptcies, were filed, but by 2003, the trend had reversed.

The 2007–2009 Financial Crisis

Many of the so-called "toxic assets" that contributed to the subprime crisis were linked to higher-yield corporate bonds. Rather than being sold as "junk status" bonds, the above mortgage or high yield instruments were given an AAA rating, leading to the controversy. Since their prices dropped during the crisis, junk bond rates have increased dramatically. Nearly this period, the YTM of high-yield or unsubstantiated bonds increased by over 20%, leading to a record high in junk bond defaults and an average market rate of 13.4% by the third quarter of 2009.

Conclusion

Nonetheless, the secondary market for junk bonds, like the primary market, always seems to bounce back from these setbacks as well as external blows. Many institutional and individual investors remain enthusiastic buyers of high-yield bonds, so issuers keep turning to them. Therefore, this long-lasting power is founded on both the ever-present requirement for cash by businesses and the ever-present yearning of investors for investment vehicles that provide greater returns on their capital than investment-grade bond offers.