J. Obie Wan.......
Corporate Bonds in Bad Shape
NEW YORK (Reuters) - Corporate bonds can't seem to catch a
break.
The bonds, touted for months by many experts as worth a
look from investors because of their bargain-basement prices,
now are only getting cheaper.
Not since the 1998 financial crisis following Russia's debt
default, when investors shunned all but the safety of U.S.
Treasury bonds, has the situation been this bad, experts said.
Prices on corporate bonds have fallen over the past week,
pushing out the yield gap between the bonds and U.S. Treasuries
by 0.1 to 0.2 percentage points.
And with corporate profits and credit quality declining, no
turnaround appears on the horizon.
``The market is jumpy,'' said Steve Bohlin, who helps manage
$1.8 billion of fixed income investments for Thornburg
Investment Management Co. in Santa Fe, N.M. ``As we see weakness
emerge, it makes people wary about their credit exposure.''
INTOLERANCE OF POOR EARNINGS
Corporate bonds yield more than super-safe Treasuries to
compensate investors for extra risk. The difference in yield
between the bonds and Treasuries is called a spread.
Since mid-September, investors have punished many of these
bonds the way they traditionally punish stocks. Earnings
shortfalls are a big reason for that.
In the last month, there has been a string of high-profile
warnings of lower-than-expected profits from companies such as
No. 1 home improvement retailer Home Depot Inc. (HD.N), No. 1
phone equipment maker Lucent Technologies Inc. (LU.N) and No. 2
cell phone maker Motorola Inc. (MOT.N).
Warnings such as these have been blamed on a strong U.S.
dollar and companies' inability to pass on high energy and
other costs to consumers.
Bond investors are showing no patience for such warnings.
And with the Federal Reserve having last week said inflation
remains a risk to the U.S. economy, and that interest rate cuts
aren't in the works, more disappointments could be on the way.
``There's a little bit more concern now that perhaps the Fed
will not succeed in engineering the soft landing,'' said Martin
Fridson, chief high-yield strategist at Merrill Lynch & Co.
New bond supply is also a concern. Bonds of
telecommunications companies in particular have performed
poorly under the weight of tens of billions of dollars of
existing and anticipated supply.
Then there are credit ``bombs,'' such as building materials
maker Owens Corning's (OWC.N) stunning bankruptcy filing last
week because of asbestos lawsuits, or persistent retail sales
weakness such as that suffered by J.C. Penney Co. (JCP.N).
On top of this, dealers have since the 1998 crisis
committed progressively less capital to the market. That causes
the liquidity of bonds in trouble to dry up.
``If you see any negative news from earnings headlines or
credit bombs..., investors will punish spreads, and because the
liquidity isn't in the system dealers aren't there to buy,''
said Stewart Morel, co-head of high-grade research at UBS
Warburg LLC in Stamford, Conn.
JUNK BONDS LOOK WORSE
The problems aren't limited to high-quality bonds.
If anything, for junk bonds, where yields and risks are
even higher, things are worse. After two years of near barely
positive total returns, many experts thought junk bonds would
recover this year. Indeed, the bonds have on occasion shown
fleeting signs of life.
Yet, it is the only major bond asset class to post negative
total returns this year, according to Merrill Lynch.
``One could look throughout the year and pick points in time
when junk bonds looked historically cheap, but the market just
keeps grinding lower,'' said Michael Guarnieri, managing
director of high-yield research at Lehman Brothers Inc.
More than $4 billion of net outflows from junk bond mutual
funds have sapped available cash. Credit quality is dropping,
with downgrades affecting more than twice as much debt this
year as last according to Moody's Investors Service. The
default rate rivals that in the 1991 recession, and Moody's
expects it to reach 8.4 percent by next September.
Rumors in the last week that three big investment banks
suffered big losses trading junk bonds jangled investors'
nerves. Small-capitalization stocks, whose movements according
to Fridson correlate highly with those of junk bonds, have been
pummeled. And, Federal banking regulators said this week the
amount of ``problem'' loans surged 70 percent from last year.
``For a number of reasons, not by any means irrational,
investors are exacting a more severe penalty from companies
that suddenly look weaker than they did,'' said Fridson.
That's unlikely to change, at least not this year, experts
said. It's a time to be defensive, not aggressive, they said.
``The macro viewpoint has changed,'' said Bohlin. ``A year
ago, when companies missed their earnings, investors would be
hopeful they would make it up in the next quarter. Now, if you
believe the economy is likely to deteriorate, it's not as easy
to believe the next quarter will be better.'' |
