|
Investors
have done well in stocks this year, but the stock market
has been chintzy compared with high-yield bonds.
As
investors have recovered their nerve, the riskiest of
bonds have soared. The Merrill Lynch High Yield Bond
index has provided "an incredible total return of
41.4 percent," according to
Moody's
economist
John Lonski
, while the
Standard & Poor's
500 has climbed barely a third of that.
Despite
some of the harshest conditions for corporations since
the Depression, the flood of money into the financial
system has made investors willing to bet that even weak
companies will be able to make their bond payments to
investors.
But with
economic conditions still fragile, advisers are
encouraging individuals to review their exposure to
high-yield bonds and cut back if they have ballooned
into a larger portion of portfolios than intended.
"High
yield has come a long way," Lonski said. There is
still room for investors to make more money if the
economy continues to improve in 2010, but
"investors are making a mistake if they think there
will be another 40 percent return anytime soon."
Steve Leuthold
, a money manager at the
Leuthold Group
, thinks 6 percent to 8 percent annual returns are
likely over the next few years.
Returns
will depend on what happens to defaults, or companies
failing to pay bond investors.
Moody's
expects defaults to fall sharply this year after hitting
a record 12.7 percent in November. If defaults do
decline, that will make high-yield bonds less risky. And
willing investors mean weak companies can bypass banks
reluctant to extend loans when they mature.
"Instead
of maturities in 2010, they might be able to delay until
2012 or 2019," Lonski said. And with less stringent
covenants than banks impose, companies that sell bonds
will have more financial flexibility.
Since
March, the appetite for bonds has generated
$88 billion
in new issuance, a return to the environment that
existed in
October 2007
.
But the
risk for investors could intensify, and companies could
have trouble accessing the bond market if investors are
shocked by a major bankruptcy akin to WorldCom's after
the 2001 recession. When investors see growing risks,
they shy away from bonds, and value drops. When
investors are feeling more confident, they buy bonds,
and yields decline.
After the
2001 recession, investors returned to high-yield bonds
until WorldCom collapsed. Issuance of new bonds then
declined 51 percent annualized as investors remained
cautious for about six months.
Likewise,
sales of U.S. high-yield bonds fell sharply last year
with fear of an economic meltdown driving average yields
above 22 percent in December. Recently, the average
yield was about 11 percent.
But
trouble signs still exist.
Globally,
corporate bankruptcy filings are up this year, said
Diane Vazza
, head of global fixed income research with
S&P
. And corporate defaults, at 213, are four times those
of last year.
Many
defaults have affected private-equity investors, those
who must continue to put money into distressed companies
to bolster their prospects, she said. Yet,
"distressed exchange offers are now the top reason
for default this year."
Vazza is
forecasting that the default rate on speculative bonds
will reach 13.9 percent by mid-2010 but could hit 18
percent. "The precipitous increase in defaults
reflects a pronounced decline in economic fundamentals
and earnings prospects, as well as the continued
unfavorable environment" for the weakest companies,
she said.
Lonski
says the key is employment, needed to stoke consumer
spending and boost companies' sales.
"August's
employment report showed that the U.S. economy is far
from healthy," he said. "A harsh recession may
have passed, but the economy is too frail to do without
the support of fiscal and monetary stimuli. The mixed
messages of August's employment report warned investors
to proceed with caution."
|
