Junk bonds have been on fire this year, generating returns of over 50%. For this trade, the credit crunch appears over and it’s pretty clear that Uncle Sam has your back if things turn south. Or at least that’s the belief.
By nature of providing financial breathing room for the entire private sector via low interest rates and easy money for the banks, while helping the less levered companies, you at the same time unavoidably provide a huge get-out-of-jail card to highly leveraged companies financed with high yield debt. In fact, the U.S. is prodding banks to lend more right now, which means easy re-financing for leveraged or operationally-challenged companies with debt maturing in the near term.
So is the junk rally over? Well given a historically awesome year for 2009, it’s hard to ask for a repeat, but Citi’s John Fenn thinks that investors will continue pouring money into high yield bond funds. Want to see moral hazard in all its glory? Then look no further than the junk bond market of 2009… and 2010:
After a record-setting year of mutual fund inflows, next year likely brings some respite, but not much. Even with high yield yielding 9%, the asset class is relatively attractive from a risk-return perspective, and the experience emerging from past recessions suggests significant inflows are likely to persist beyond one year. Certainly, $32 billion of retail inflows trumps the next highest year on record, 2003, by a comfortable $4 billion. However, during the period the size of the market has grown by roughly 40%. As Figure 13 indicates, on a percentage basis, retail flows in 2009 were less than 2003 and also a number of years in the nineties when the market was much smaller. The takeaway, in our view, is a repeat of the 2001-2003 period for high-yield mutual funds implies another $32 billion of inflows over 2010 and 2011.
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We’re not saying junk bond yields should rally, as in they’re good value. The point is that money is likely to keep pouring into them. Until they get slaughtered and it’s too late. Unless they’re bailed out again.
(Via Citi Investment Research, High Yield – Outlook and Strategy, John Fenn, 23 December 2009)