The primary threat to the high-yield market isn't a wave of corporate defaults, but rather a reversion of the compressed risk premium that investors demand. This premium has been historically low, and a return to normal levels presents a significant valuation risk, even if fundamentals remain stable.

Contrary to fears of a spike, a major rise in 10-year Treasury yields is unlikely. The current wide gap between long-term yields and the Fed's lower policy rate—a multi-year anomaly—makes these bonds increasingly attractive to buyers. This dynamic creates a natural ceiling on how high long-term rates can go.

Concerns over US term premium have receded partly because the Treasury buyer base has stabilized. The declining share of price-insensitive buyers (Fed, foreign investors, banks), which fell from 75% to 50% over a decade, has finally stopped falling, creating a more supportive demand backdrop.

While default risk exists, the more pressing problem for credit investors is a severe supply-demand imbalance. A shortage of new M&A and corporate issuance, combined with massive sideline capital (e.g., $8T in money markets), keeps spreads historically tight and makes finding attractive opportunities the main challenge.

In an overvalued market, stable pharmaceutical companies with strong dividends and modest growth can serve as a safe place to park capital. They offer a yield comparable to T-bills but with added upside from growth, acting as a defensive equity holding.

Howard Marks argues that you cannot maintain a risk-on posture and then opportunistically switch to a defensive one just before a downturn. Effective risk management requires that defense be an integral, permanent component of every investment decision, ensuring resilience during bad times.

Since 2022, highly leveraged hedge funds have bought 37% of net long-term Treasury issuance. This concentration makes the world’s most important market exceptionally vulnerable, as any volatility spike could trigger forced mass selling (degrossing) from these funds.

For 40 years, falling rates pushed 'safe' bond funds into increasingly risky assets to chase yield. With rates now rising, these mis-categorized portfolios are the most vulnerable part of the financial system. A crisis in credit or sovereign debt is more probable than a stock-market-led crash.

The modern high-yield market is structurally different from its past. It's now composed of higher-quality issuers and has a shorter duration profile. While this limits potential upside returns compared to historical cycles, it also provides a cushion, capping the potential downside risk for investors.