Junk Bonds: Playing for Pennies, Risking Dollars

I try to avoid investments where the upside is limited, but the downside is unlimited.  That’s the way I feel about junk bonds now.  Have junk yields been lower before?  No, we have eclipsed the time in 2003 when the junk market was in a yield frenzy, until Bernanke uttered the word “taper.”

There are a lot of desperate retirees seeking income, assuming it is free, and not merely a return of capital.  There are a lot of desperate people seeking certainty in investing and do not realize that dividends are a handmaiden of value, and not value itself.

There are a lot of desperate pension plans looking to make up for lost time, and hoping against hope, buying dividend paying and growth stocks, high-yield bonds, alternatives like hedge funds, private equity, etc., at the wrong time.

Those are the things you should buy when stocks are cheap and people are scared to death.  You sell them when people are confident, and valuations are high.

Valuations are high; not nosebleed high as in 2000, but high as in comparable to the peak in 2007.  Could things go higher?  Yes, but you are playing for pennies and risking dollars in the process.  Those with a value and quality discipline will likely fare better in the process, but markets are messy, and what actually happens will be a surprise.

Thus I would encourage you to consider the credit quality of your stocks and bonds.  What kind of shock could they withstand?  When yields are low, like they are now, the system is less resilient to credit crises.  Be aware, and be on your guard.

About David Merkel 144 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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