Tuesday, October 25, 2011

Junk Bonds are Back in Business (For Now)

For individuals just struggling to get an honest list of the best checking accounts offers in a bad economy, junk bonds probably sound like a bad idea. Generally speaking, they'd be correct; the potential yields of junk bonds, otherwise known as high-yield bonds, are far from the safe assurances of certificate of deposit rates. In fact, these particular bonds belong in their own class solely because they're rated below investment grade and are therefore too risky to pool with other bonds. In typical economic tough times, experts tend to advise investors to stay away from high-yield bonds – the risk for struggling entities failing to oblige to the returns is just too great.

But these are not typical economic tough times.

No doubt about it – it's tough right now. But it's a different kind of tough. It's so different that nobody really knows where the market is headed, and that's reflected in the wily way in which we've seen investor confidence fluctuate in recent months. Europe in particular is fighting to avoid economic calamity on a historical scale. Up until now this has resulted in major abandonment of junk bond dealings in favor of the much safer alternative – U.S. Treasuries. Both foreign and domestic investors have flocked to Treasuries, which has resulted in a lowered yield, creating an unprecedented gap between Treasury yields and those of high-yield corporate bonds.

Typically, such a gap was bad news for junk bond enthusiasts. But as it turns out, the European safeguards against high-yield default are much more bearish than what analysts say is necessary. Current buyers of junk bonds linked to the Euro are being compensated for a 7% default scenario, a much higher rate of default than experts believe is going to be the case in the European high-yield market. Even lower anticipated rates of default exist in the U.S., encouraging investors to give junk bonds a second glance, at least in the meantime.

That means that, for now, junk bonds are looking like a sure bet to many investors. The current trend is to descend on the best-rated of these bonds – those rated B or BB. But if the division between Treasuries and bonds stays true while European debt fears subside, you may even start to see investors brazen enough to buy up lower-rated bonds, although experts caution that these riskier junk bonds are bound to come with higher default rates.

Will small-time investors and those used to CDs suddenly become junk bond aficionados? Probably not. But at a time when uncertainty is the only sure thing, speculative bets on risks – and the benefits of enough bond buyers doing that – might just become the next big thing for amateur financiers.

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