When money market funds, mutual funds and CDs yield next to nothing, the old itch to find higher yields kicks in. That may be why Bloomberg has had a field day reporting on the latest attempts to find higher yields. For example, from an October 7 story:
Private-equity firms are taking advantage of record demand for high-risk, high-yield debt to pay themselves dividends, saddling their companies with additional loans and bonds. … Shareholder payouts funded with bond and loan issuance climbed to $24.2 billion this year, more than triple the amount for all of 2009 and the most since the Standard & Poor’s 500 Index peaked in October 2007, according to S&P’s Leveraged Commentary and Data. (Bloomberg, 10/7/10)
The yield may be high today, but Robert Prechter warns that it's a dangerous game to play. He sees it as tomorrow's next investment disaster. Read more in this excerpt from his September 2010 Elliott Wave Theorist.
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Excerpted from The Elliott Wave Theorist by Robert Prechter, published September 17, 2010
The Next Disaster
Optimism is playing out another way. Many commentators have noted that the public has withdrawn some money from stock mutual funds in order to buy bonds. If people were pouring into Treasury bonds, it would be a bullish sign, because it would reflect waxing conservatism. But most investors are not hiding in Treasuries; they are chasing yield! To that end, they are shunning Treasuries to invest in high-yield money market funds and bond funds, which hold less-than-pristine corporate and municipal debt. To show you how divergent these trends are, reports show that taxable corporate bond funds took in $26 billion in August and muni bond funds attracted $5 billion, but long term government bond funds drew only $191 million! But wait. It gets worse. Read these jaw-dropping excerpts from two Bloomberg reports:
- Junk debt prices climbed to 100.115 cents on the dollar yesterday, the highest since June 2007, before record defaults on subprime mortgages sparked the worst financial crisis since the Great Depression.… (9/17)
- Two years after the bankruptcy of Lehman Brothers Holdings Inc. caused credit markets to freeze, investors are embracing bonds backed by loans to consumers with weaker credit scores as yields approach all-time lows. Issuers have sold $4.4 billion of bonds tied to subprime auto loans this year, more than double the amount arranged in 2009.... (9/16)
The public always does the wrong thing. Investors have gone from the frying pan (the NASDAQ in early 2000) into the oven (real estate in 2006) into the steamer (the Dow in 2007) onto the grill (commodities in 2008) and now into the fire. Each time, they are sure that their decision is sound. But once again, it is not.
Remember in 1999-2007, when stock buyers were sure it was “all about incremental earnings”? The same belief held in 1927-1929 (see chapter 13 of Market Analysis for the New Millennium), and both times it devastated investors. Now it’s all about “incremental yield,” with no regard whatsoever for the safety of principal. Bond investors, to put it bluntly and literally, are out of their (rational) minds, as much as they were on stocks and subprime debt in October 2007, the month of the all-time high in the Dow. By 2016-2017, the issuers of today’s high-yield bonds, and even today’s A and AA bonds, will almost certainly be in default across the board. When pessimism finally overwhelms the financial markets, both the principal and interest on these bonds will become unpayable.
Get the rest of the story to learn Prechter's advice on how to stay safe in the September 2010 issue of The Elliott Wave Forecast. Read more about it here.