Investors eventually feel foolish—on the way up when they sit out rallying markets, or on the way down when they ride losses too far. That tension framed a deep dive into high-yield bonds, equity valuations, and practical hedging. We started with history: from 2007 to today, high yield delivered modest returns with meaningful drawdowns and rising equity correlation. On a shorter lookback, the asset class seems like a diluted version of equities, capturing less upside than downside. Pull the lens back to 1985, though, and the math changes. Through a full rate cycle, high yield showed materially lower volatility, shallower drawdowns, and a better upside-downside capture mix, especially for investors who value predictable cash flow and can use leverage prudently.
That’s the institutional lens: match liabilities with income, manage to maturities, and avoid price-target guesswork. Bonds are contracts; their return is mostly inside the term sheet. Equities, by contrast, are open-ended—great when multiples expand, painful when they compress. With the S&P 500 at stretched valuations, forward 10-year return models suggest low single digits, even near zero, on average. Against that backdrop, a 7 to 8 percent all-in yield from credit looks sane. But today’s spreads around 300 basis points over Treasuries are historically tight, implying more downside than upside. That’s where convexity matters. Use a slice of portfolio income to buy protection—credit default swaps that benefit if spreads widen—not because defaults must surge, but because pricing underestimates the path between now and maturity.
Hedging is not an all-or-nothing bet. As spreads move, protection can appreciate even without actual failures, letting investors monetize fear and redeploy into dislocations. This is especially powerful when paired with disciplined profit-taking in bonds that rally above par and with selective equity participation via defined-risk options. One compelling posture now is long upside in equities through calls, funded by income, while short credit via CDS to express the skew in spreads. The aim is to stay in the game if risk assets melt up while guarding against the credit cycle’s hard turns. Importantly, this approach accepts that markets can stay irrational longer than expected, and that being “right later” is often where real money is made.
We also dug into private credit and AI infrastructure. Data centers are capital intensive, low margin, and often financed through securitized tranches. Over the summer, risky slices were oversubscribed, even at 10x leverage—the kind of setup where a 10 percent miss in cash flows can zero out the bottom piece. Some contracts embed opt-outs that can cascade if AI demand underwhelms or if efficiency gains reduce required power and space. That’s not a call for doom; it’s a reminder that credit cycles cleanse excess. Developers may win on promote, while late buyers inherit refinancing and obsolescence risk. When technology leapfrogs—think next-gen chips or new battery chemistries—capex needs reset, balance sheets strain, and the most aggressive projects suffer first.
Sophisticated retail can borrow the institutional playbook: map cash needs, prefer resilient income, and reserve flexibility to buy when spreads blow out. For larger portfolios, surviving the big down years matters more than maximizing every up year. You don’t need to predict the top; you need to predefine your response. Tight spreads invite humility and hedges. Rich equity multiples call for defined upside, not blind shorts. The goal isn’t to pick a single story—AI forever or recession tomorrow—but to structure exposures so multiple stories can pay you while the math stays on your side. Prudence may feel boring, yet it compounds surprisingly well when the cycle turns.