Thursday, July 09, 2009

Time for High-Yield Junk Debt Again?

Bond Broker
High-Yield Debt: Is It Time To Fill Your Trunk With Junk?

To the tune of "Putting on the Ritz" "If you're blue and don't know where to go to . . . Why don't you go where high-yield sits, Putting on the Risk."

In case you haven't had your radios tuned to W-A-L-L Street, junk is now music to the ears of the financial mainstream. To wit: In the first half of 2009, high-yield bonds saw a whopping 28.6% return, completely erasing the 25% shortfall from last year. Also, an estimated $41 billion in corporate debt was issued, an 81% increase from 2008.

All in all, it was junk's best first-half performance since the 1980s. By comparison, US Treasury's endured a 4.4% loss and suffered their worst six-month performance since Merrill Lynch began tracking the sector in 1977.

It goes without saying, investors who chose risk made out like bandits; while those who opted for safety made out like the poor flubs being robbed by said bandits. And, according to the usual experts, the boom times for BBB ratings (and below) have only just begun.

On this, the following news items from recent weeks capture the full extent of risk-grab glory:

"The second quarter was about the dissipation of fear and the resumption of greed. The lights are coming back on in trading desks." (Wall Street Journal)

"Corporate Bonds Look Like A Good Bet" (DJ MarketWatch)

"Nowhere is the recovery in financial markets more evident than in corporate bonds. The gains may be the clearest indication that the $12.8 trillion pledged by the government and Federal Reserve to thaw credit markets is starting to pull the economy out of the worst recession since the 1930s." (Bloomberg)

Translation: As the economy recovers, so will junk. ---- Or will it?

High Times For High Yield? The July 6 Short Term Update presents a compelling price chart of a major junk bond index that shows whether the grab for risk will end in gains, or pain. Click here for more.

In his 2002 book Conquer the Crash, Bob Prechter made the following observation: The more convinced the mainstream becomes in an end to the recession, the stronger becomes their conviction that "now is the perfect time to buy depressed junk bonds."

Bob then squashes the notion via this myth-busting picture of the High Yield "Junk" Bond Index from 1987 to 2002.

Look closely: During the most rampant economic growth of the 1990's bull market, high yield debt plunged 70% in value. In Bob's own words: "Those high-yields were a chimera."

This picture is a stunning reminder of one key point: In a genuine bull market, investors don't have to chase after, or borrow for -- returns. Returns come to them from the highest quality instruments out there.

In the 2003-2007 rally, junk bonds rose alongside stocks as a debt-propelled liquidity bubble pushed all markets up together. Then, once the credit bubble burst, the whole leveraged system came tumbling down.

At the end, the notion that junk bonds rise with the economy is just one in a long line of false-causality claims held by the mainstream -- one that leads its followers down a very dark path.

The July 6 Short Term Update presents an objective chart of a major Junk Bond index which suggests where high-yield -- and the economy as a whole -- will be in the months to come. Click here for more information.