Junk bonds can be similar to stocks since speculative companies can issue them in order to raise capital.
Junk bond analysis also involves many of the same features of stock investment since even a company’s near-term operating performance can have a large effect on junk bonds’ market price.
Highly rated corporate bonds, on the other hand, are usually fine regardless of near-term operating performance as long as default isn’t even conceivable, such as say with Procter & Gamble (PG), and their analysis is more closely aligned with potential interest rate movements.
Thus while most companies simply don’t have the option to issue highly-rated bonds (an unstable/new growth business just won’t get the debt rating of PG), many have the choice between issuing shares via an IPO/share offer, or issuing high yield ‘junk’ debt.
And thanks to the open secret that the Fed will keep debt cheap, right now the choice is a no-brainer.
According to Moody’s, the number of companies at high risk of default is near a two-year low very much thanks to the Fed-induced expectation that interest rates will remain low for a long time:
Companies rated at or below B3 with a negative outlook declined to 195 as of Sept. 1 from a high of 288 in June 2009, Moody’s said in a report. The B3 rating is six steps below investment grade. Clear Channel Communications Inc. and Energy Future Holdings Corp., formerly named TXU Corp., were among the biggest companies on the list.
“What’s interesting is the snap back,” David Keisman, senior vice president at Moody’s in New York, said in a telephone interview. Increased liquidity is helping to improve credit quality and lessen default risk, he said.
Fueling the fire, investors also love junk bonds these days as shown by high demand for new issues and shrinking spreads (interest on bonds demanded). People are scared of stocks, yet reaching for yield:
Speculative-grade debt sales in the U.S. jumped to $184.2 billion this year compared with $100.1 billion in the same period of 2009, according to data compiled by Bloomberg. Sales of $119 billion [of junk bonds] in the first half were the most since Bloomberg began compiling the data in 1999.
The extra yield investors demand to own U.S. high-yield bonds instead of Treasuries declined 85 basis points this quarter to 632 basis points, according to the Bank of America Merrill Lynch U.S. High Yield Master II index.
So thanks to the Fed and current investor sentiment, the interest costs on any debt you issue are pretty low, even for the more speculative issuers. Meanwhile if even a stable company IPO’s or issues new shares, it gets a far lower valuation relative to its earnings than it used to, due to where the stock market trades these days.
Thus for any IPO or share issue you do see, take a moment and wonder, ‘Why aren’t they issuing junk bonds instead?’ And for each junk bond issue? ‘Yep, they’re playing this market like a fiddle’.