Bonds are an easy investment to understand:
You lend money to a borrower for a certain period of time. The borrower promises to
1) Pay a fixed rate of interest on the loan, and
2) Pay back the original loan when the time period ends.
Simple, as I said. Bonds have long been a favorite of investors who want a stable vehicle for their assets; U.S. Treasury bonds are widely seen as the safest of all.
So what would you think of a "bond" that allowed the borrower to skip interest payments, with a promise to pay the interest later?
If you think "That means the borrower promises to keep a broken promise," you're spot-on. Welcome to the world of payment-in-kind (PIK) bonds.
You may also think "That's crazy." I understand. But, given PIK bond sales recently, "crazy" is spreading: For all of 2010, PIK bond sales amounted to $375 million; in 2011 so far, PIK bond sales have reached $1.3 billion.
Now, details about how PIK bonds work are less important that the psychology they reflect: In other words, PIK bonds are a near-perfect way to understand today's financial sentiment.
Back in 1999, "burn rate" was the trendy phrase among dot-com entrepreneurs to show bravado over who could spend venture capital the fastest. And back around 2006, "NINA" mortgage loans (no income, no assets) reflected the loss of sanity in the housing market.
You get the idea. You know that "crazy is spreading" when you see the spread of crazy financial instruments -- like PIK bonds.
Perhaps you know that this instrument isn't new. It's true that they were briefly popular back in 2007.
But the larger point is that it's been barely three years since we all saw exactly how a story like this must end. Now it's worse. Previously the toxic assets were based on subprime mortgages linked to a tangible asset (property). Now the toxic assets are based on two intangibles -- namely, the promise to keep a broken promise.
Please consider a few more quantitative measures of where investor psychology is today. A recent survey shows that investors are the most bullish they've been in seven years. Money managers have record high levels of stock holdings. Hedge fund managers have adopted the heaviest commitment to stocks on record.
Investor psychology is critical to your financial future. Understand it, and you will understand the trend that drives prices. The new April issue of The Elliott Wave Financial Forecast explains where that psychology is now, and where it's going next. It does spell out what PIK bonds mean, yet it gives you much more -- including a detailed, fact-based forecast of exactly where the stock and bond market trends are headed next.