Should You Own Junk Bonds?

We think the time is right for high-yield bonds. We hold profitable positions in these securities in personal and client accounts. The yields offer an attractive alternative to most of the common shares, and have less chance of default or dilution. Naturally, we are very attentive to comments on prospects for these securities.

Our attention focused on this item from Zero Hedge:

...everyone is ignoring that 20% of these names will be bankrupt by year end, unless Obama and TTT nationalize everything, in which case look for the first 5 year plenary session some time in December, complete with parades by the 91st and 341 Missile Wings showing off their Minuteman III arsenals (reduced to single warhead delivery to comply with START I)

Unlike most readers, we click through to the source, which reads as follows:

“Champagne might be a little premature,” Gregory Peters, head of credit strategy at Morgan Stanley in New York, said yesterday in a Bloomberg Television interview. “You’re still facing the biggest distressed default cycle that we’ve ever seen.”

Moody’s is forecasting the default rate among high-yield companies globally to soar to 14.8 percent by year-end from 8.3 percent in April as companies that financed a record amount of high-yield, high-risk debt leading up to the credit crisis struggle to refinance.

Our Take

A key skill for investors is to verify the accuracy of sources and their evidence. We highlighted this problem, and noted the difficulty when readers uncritically accept the summaries provided by popular sources. The summary from this author is not accurate when one looks at the source material.

The other key point in this case is the intermingling of a political viewpoint with investment advice. There is plenty to analyze about the Obama Administration. We work on this daily at our sister site, ElectionStocks.com, where we link policy proposals and decisions to stocks. Our approach is strictly analytical. We note successes and failures, and did the same for various candidates and the Bush Administration. Our approach is not partisan -- strictly oriented to investment success.

Those who start with the conclusion -- an attack on government policy -- and then look for evidence, may be in for a long four years of bad investment decisions.

Disclosure: Long PGF

Comments

[NormK:]

At the bottom in Nov and March, I went long on JPS preferred ETF and NXG, speculative mining and am up 70% on both with hopefully a nice long ride to go. Like Cetin, I liked oil & gas so I picked up one of the biggest outside the US, Gazprom, symbol OGZPY which is up about 50%, at 21 but still a long way from their $60 high a year ago. I tried to convince my friends and family to buy these but nobody listened but I still think there is good upside to all three.

May 08 12:00 PM

[user396040:]

I tend to agree with the article. Junk bonds have had a good run the last month or so but I think there are still bargains. You have to be careful about the debt structure with respect to individual issues. On closed end funds, you have to be careful and not buy at a big premium to NAV, but there are still high yield funds trading at sizeable discounts. I have done very well with AFC(Allied Capital bonds), FSB(Financial Security Assurance bonds), GMAC bonds, and the Helios family of closed end funds. Back in the Fall I got in and out of bank bonds when there was a scare after the WAMU debacle followed by a price surge when it began to become clear that WAMU was not going to be the paradigm for how the government would deal with banks. I have also taken my lumps with Idearc bonds and GM bonds. The nice thing about this sector is that you get paid a very high yield while you are waiting for things to sort themselves out.

May 08 12:27 PM

[Fabien Hug:]

The default rate is already priced in. So far, all pessimistic scenarios are not validated by the market. Hi Yield bonds funds offer great monthly dividends. It's been a buy since the government said (I don't remember if it was Geitner or Bernanke); "we'll do anything it takes to solve that crisis". I'm long HY bond funds. I buy those ranking 4 starts minimum in Morningstar.

May 08 03:13 PM

[Old Trader:]

I think Jeff Miller is 100% correct in cautioning investors to separate thier personal political views from their investment decisions. The two don't always equate.

May 08 10:22 PM