Sunday, February 21, 2010

Whither Junk?

The beginning of 2010 hasn’t been quite as smooth as most of 2009 was for the junk bond market. Some fear here and there, a pulled deal or two and risk spreads have widened a bit.

However, there is nothing really dramatic in this pullback. So far this year the FINRA-Bloomberg High Yield index is still up about 0.2%, but it’s 1.6% off the high achieved on Jan 11th. Compare that to some stock indices, a few of which (Spain) are down double-digits for the year and you’ll see junk has suffered only a “mild setback” in comparison.

Naturally, after a year that saw this index rise 44%, expectations might be a bit exaggerated not only from those riding the wave, but also from those anticipating a fall from those perceived “heights”

Still it’s always good to reassess one’s position. And mild or not, a setback is a loss and nobody wants to lose. So what now?

After thinking it over for about two minutes , I’ll be sticking with my junk for now thank you and here’s why:

1. The alternative is nothing. Not saying that there is no alternative, but if you’re
looking for something “safe” a 12-month FDIC insured CD at Bank of America is paying 0.80% APR. Two years: 1.11%. It’s quite ridiculous. Sure, bonds (and junk) aren’t really ‘safe”, but do you really want to give your money away to the big bad banks?

2. Money continues to flow into bonds. The Investment Company Institute tracks money flows into money market and mutual funds. During 2009, the net flow into bond funds was $374 billion dollars vs. a NEGATIVE flow of $9 billion for equity funds (which is pretty much a wash). Where is the money coming from? Money market funds (down $566 billion in 2009) and bank CDs (see point 1). Some money market funds are paying 0.01% because they can’t pay “negative” interest.

3. The boomers are getting older. The oldest boomers will be 64 this year and the youngest 46. E*Trade took a survey in 2008 (before the crash) and a majority of investors believe they are underweight in bonds and should be looking at allocating more. LINK.

4. Deleveraging continues. Despite the fact that credit is becoming easier, companies are looking to reduce debt, either by issuing equity or other means. LBO activity, which normally has the opposite effect (new issuing of debt to retire equity) has been very light.

Money flows and lack of attractive alternatives. This clip probably sums it up.

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