Junk Bonds 2009 : Too Risky Or Great Opportunity ?
2008 was a bad year for stocks and credit alike. The Credit Crunch and global financial crisis meant worsening and at some levels disaster credit flow conditions for companies and governments alike and as remarked by Wall Street Journal :
The relationship between U.S. stock and credit markets is ending 2008 in fittingly dysfunctional fashion.
For much of the year, the two markets have been out of sync, with credit often worsening even as stocks rallied. Now, credit seems to be improving, but the stock market isn’t.
Junk bonds, that are also defined as high yield bonds (click herefor a full definition of Junk Bonds from Wikipedia) has now in some investors’ minds traded down to tempting levels as well and whilst the risk remains high in terms of defaults some are now pointing to these junk bonds as a prospective investment opportunity.
This post looks into the pros and cons and Junk Bond investments and where they are possibly headed here on the threshold of 2009.
Toby Shute from Fool.com has this to say about Junk Bonds as a viable investment right now :
Whether you opt for an exchange-traded fund or a closed-end fund, both provide a convenient way to pick up a diversified basket o’ distress. Corporate defaults are definitely headed higher, but the firms that survive ought to generate returns that are fabulous enough to outweigh the zeroes. That’s all the more true if you buy during another dramatic sell-off akin to what we saw in early October and late November.
Shute goes on to also recommend individual securities if one is more hook on companies’ debts :
If you’re bearish on the broader economy, or your inner stock picker urges you to hone in on individual securities, there is another easy way to dip a toe into this part of the market. There’s a fair amount of debt out there that’s listed on a stock exchange and traded just like stock. The usual denomination for these notes is $25, so you’ll see them trading around that price in normal times — remember those?
General Motors (NYSE: GM) has exchange-traded debt priced at around $3, or a dozen pennies on the dollar. But that discount isn’t altogether unreasonable, and it’s not really the kind of opportunity I’m thinking about.
More interesting to me are cash cows like Comcast (NYSE: CMCSA)and CBS (NYSE: CBS). Comcast, the largest cable company in the country, has a note (ticker: CCS) trading below 80% of par. Viacom (NYSE: VIA)spinoff CBS has two issues (tickers: CPV and RBV) trading around $0.50 on the dollar. That is pretty astonishing for an investment-grade credit.
I know both companies are likely in for a rough 2009, but visions of default do not dance before my eyes.
Stephen Taub of CFO.com analyses what he sees as a deterioating credit quality among U.S. speculative-grade issuers in recent months and goes to list the dire credit news of 2008 :
Total downgrades for the year reached 518 as of Dec. 17, the most since 2001. What’s more, the 311 downgrades in the second half of 2008 make the highest second-half total ever, already eclipsing the total of 308 in 2001. “We expect downgrades to continue at this pace in the first half of 2009,” S&P predicted in a new report.
The percentage of issuers with negative bias — those designated as “CreditWatch negative” or with a negative outlook — has climbed to 37.5 percent, nearly a six-year high.
Mark Gongloff of WSJis somewhat mystified that the stock market has not recovered after the Federal Reserve recently lowered its base rate down to zero, making colerporate lending easier for US companies but offers a couple of likely explanations :
One possible explanation is that credit markets are behaving as they sometimes do after dramatic Fed actions — bears rush out, then bulls rush in but end up burned.
Something similar happened after big Fed cuts in September 2007 and January 2008, notes Brian Reynolds, chief market strategist at WJB Capital Group. Each time, credit enjoyed a brief rally that ended in tears. This time, credit speculators may be hedging their bets by shorting stocks.
and if this is not the case he has another couple of explanations ready at hand:
A more benign interpretation is that stocks are simply lagging credit, as they have for much of this crisis. Thin holiday trading could be exaggerating moves in credit or muting the stock-market response. That suggests the stock rally that began after Nov. 20 and petered out on Dec. 15 could resume with the new year.
But another possible explanation is that, while credit has improved some, it hasn’t improved enough to offer assurance to stock investors. Even after their recent rally, high-yield bonds still fetch nearly 20 percentage points more than Treasurys, a bit wider than at the recent stock-market bottom on Nov. 20.
Whilst he admits the usual relationship between bonds and equity is not clear as present he does not see any signs of the US economy slipping into the much-feared Depression though despite the lacking US stock market uptake:
Given the massive jolts of stimulus being fired at the economy, a depression seems unlikely. But the economy isn’t healthy, either. The upshot: Credit could recover even further without sparking much of a response in stocks.
Randall W. Forsyth of Barrons.com draws parallels to the 1930s Depression when it comes to the corporate bonds’ spread:
Yields of Baa-rated bonds fell from about 9.25% when that column ran to a little bit over 8%. That decline roughly paralleled the plunge in U.S. Treasury- bond yields over that span, which means corporate bonds’ spread — the extra yield investors demand to compensate for risk — has remained near the peaks of the 1930s. The question is whether corporate defaults will equal those the Great Depression.
Looking ahead Forsyth quotes two leading players in the bond market for predicting further price gains and hence yield declines :
The narrowing swap spread is a harbinger of further contraction in corporate bond spreads, according to Michael T. Darda, chief economist of MKM Partners and an early bull on Baa corporates at their peak yields in October. He sees further price gains (and yield declines) ahead. Darda notes that corporate bond yields peaked 17 months before the economy bottomed in the last cycle. That would be consistent with his forecast of a recovery coming not until late 2009 or 2010. Junk bond yields topped out 11 months before the economy’s trough, so there’s still time to buy speculative-grade debt by that schedule.
Similarly, Jeffrey Rosenberg, head of credit research at Banc of America Securities, also thinks high-grade corporates yielding over 8% offer return potential that’s competitive with equities, but with lower risk. He also favors sticking with investment-grade bonds until the default picture in leveraged finance becomes clearer-before being tempted by 22% yields on junk debt.
Whether or not investing in high-risk debt as junk bonds are is the way forward in 2009 obviously remains to be seen but it seems that analysts agree that the market situation at present is quite unique and may offer good returns for the risk prone investor. The question is of course if Junk Bonds is a better option that buying back into the stock markets which now seem set for some kind of return if not a bull market come the 2nd half of 2009.
This blog will continue to follow the at present off relationship between bonds and equity.
Bond Investments, Investment Securities, Investment opportunities, US Investments