Remember junk bonds from the days of Michael Milken, big hair and Jacko before his transformation?
BusinessWeek just reported on the hot junk bond market. This was followed up by support from Bloomberg. com, Jeremy Grantham and Merrill Lynch reports – sounds like a critical mass of opinion. Why the rally?
Junk bonds are safer than stocks. Corporate bondholders are ahead of the stockholders to get a piece of the pie, in the event of a liquidation. Corporate earnings have been weak, to say the least, driving down the price of stocks. And interest rates are close to zero. We need returns somewhere!
You would think people would have learned their lesson about investing in below investment-grade debt, but how’s an investor to get some returns? Junk bonds are really not that bad, in spite of their name. After all, as I just mentioned, they are safer than stocks. But they may have already had their run.
BusinessWeek reports that in 2009 junk bonds returned 52%. In the same breath, they also report that the S&P 500 is up 19% since the beginning of the year, but of course that is after the collapse last fall. Over the last 23 years, stocks and junk bonds performed similarly, but this year the junk bonds have done better.
I don’t see corporate earnings turning up by large amounts anytime soon – we should not expect to see the Dow much above 10,000 anytime soon. There are even folks mentioning a possible “double-dip recession” which happened in 1937, just as the United States was trying to climb its way out of another great recession.
One analyst at Merrill Lynch describes the “flight up the capital structure”. This means that investors are looking for something safer than equities, while still investing in something issued by a corporation. And, for institutions, investing in bonds gives a longer maturity than bank debt. But, if we are really in a recovery, corporate earnings will strengthen, and the stock market will follow. But don’t hold your breath, that will take a while.
Check Bloomberg.com for a healthy debate on credit vs. equities – which is better to invest in now. This is why it is so important to follow an intelligent investment strategy and not to get caught up in the product dujour.
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