Tags: Junk | Bonds | risk | bubble

NYT: Junk-Bond Boom Might Fuel Another Bond Bubble

Thursday, 16 August 2012 08:29 AM

The market for "junk" bonds, or risky corporate debt that pays high yields, is on fire, even though analysts warn the market has become overheated and is primed for a fall, The New York Times reports.

Paltry returns on government debt, coupled with swings in equities markets, have sent investors scrambling in search of risky-but-rewarding assets. Investors hope to find a venue that returns more than the rate of inflation and won't soar one day and tank the next.

Junk bonds have proven to be the venue of choice, experts say.

Editor's Note: The ‘Unthinkable’ Could Happen — Wall Street Journal. Prepare for Meltdown

Junk bonds have returned 10.2 percent year-to-date, according to JPMorgan data cited by The Times, while the yields on Treasury securities have stayed below 2 percent for much of the year.

“In a yield-starved world, high-yield bonds are right now the only game in town,” says Les Levi, a managing director at the investment bank North Sea Partners, according to The Times. “The market is giddy.”

The Federal Reserve has kept interest rates so low that returns on Treasury securities aren't even keeping pace with U.S. inflation rates.

Demand for junk bonds is so hot that the yields on these otherwise high-risk corporate debts are falling as investors line up to invest.

Average yields on junk bonds have dropped to 6.6 percent, a near-record low, according to Barclays data cited by The Times.

Yields on junk bonds have also declined because the price of a bond moves inversely to its yield. As junk bond prices have increased, yields have decreased. The return on a bond is made up of its interest rate and price appreciation.

“It’s amazing: You’re now seeing 4 to 5 percent yields for weaker companies,” says Adam B. Cohen, founder of Covenant Review, a credit-research firm. “These are the type of yields that you used to see for blue chips like Exxon and Pepsi.”

Nevertheless, yields on the 10-year Treasury note have risen from rock-bottom levels recently, as investors feel the U.S. economy is improving.

Still, a recent report by Bank of America warned investors against diving hastily into the junk bond market since there is little hope for additional price appreciation and the companies issuing this debt are susceptible to a cyclical swing in the economy and slowing business conditions, The Times reports.

“This is not a sustainable state of affairs,” wrote the BofA analysts Hans Mikkelsen and Oleg Melentyev.

As banks and investors are jumping into the junk bond market with both feet, some experts worry a bubble is forming.

"It's not yet unduly dangerous, but we're moving in that direction," Wilbur Ross, the billionaire chief of buyout firm WL Ross & Co., tells The Wall Street Journal.

Some find the trend worrisome. "These are small steps toward less-disciplined capital markets," Howard Marks, chairman of Los Angeles-based Oaktree Capital Group, tells the paper.

Former FDIC Chairwoman Sheila Bair says the Fed’s low interest-rate policy is to blame.

“Yield-hungry investors are taking on more and more risk. Pension managers are investing in hedge funds, and gullible investors are buying up junk bonds,” she writes in Fortune.

Editor's Note: The ‘Unthinkable’ Could Happen — Wall Street Journal. Prepare for Meltdown

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