As much of the nation’s focus is on the soon-to-be-passed Stimulus Bill, and the tragic Buffalo plane crash, there’s other news that bears notice.
This week, corporations have rushed to take advantage of the opportunity to raise capital, in order to pay down their spiraling debts. They’ve done so by creating a raft of new high yield, low-rated bonds.
While yield-starved investors—including mature women, whom I seek to inform and empower financially–are likely to attack these as would a shark sensing blood in the water, allow me to issue a warning that there will be blood in the proverbial streets if/when these bonds default.
Remember what our mothers taught us. If it sounds too good to be true, it probably is.
Let’s start with some definitions first. There are two major bond ranking agencies; Standard & Poor’s and Moody’s. “Junk bond” is the slang term for Lower Rated/High Yield Bonds. Technically a bond that is rated a letter rating lower than BBB- by Standard & Poor’s and rated below Baa3 by Moody’s is called High Yield, or Junk. US Treasury Bonds are rated triple AAA by comparison.
So while the excess “spread” between the yield of US Treasuries and Junk Bonds has narrowed to a whopping 16%, having been almost 22% in mid December, investors need to exercise extreme caution, IF they purchase junk bonds at all.
The rating systems were designed to act as an indicator of credit worthiness, and bond ratings would generally be thought of as welcome information, providing education to bond purchasers. That is, people who actually research this information before they buy.
However, many commission starved bond dealers and brokerage house registered reps tend to SELL investments to their clients; with nowhere near as much regard for suitability as that of their percentage commission unfortunately. Yes, it’s true.
Granted, many of us in the fee-only financial advisory business have been sorely disappointed (if not a far stronger word) in the failure of Moody’s and Standard & Poor’s to issue adequate or accurate warnings for many of the world’s companies that have since gone quite South. However, Moody’s has just revamped their predictions of global bond defaults as soon as this November to over 3 times that of the current rate, an already high 15.1%.
So, don’t be duped by this week’s flood of high yield bonds. While I hate to be redundant, pigs get fatter, hogs get slaughtered! You will have long forgotten where you spent that extra short-term yield, once your junk bond defaults and not only is the income lost, but the principal right along with it.
Please invest responsibly!