NEW YORK (CNN/Money) - Scratching your head over investors' heavy appetite for risky assets? Where else are they supposed to go?
Thanks to the Federal Reserve's easy money policy, and its indication that it can be patient before tightening up the screws, there isn't much money to be made in safe investments anymore. The 10-year Treasury's yield of just 4.1 percent isn't going to get anyone that condo in Boca. The 5.6 percent yield on triple-A rated corporate bonds ain't much better.
And so investors have been reaching for yield, seeking higher returns. Last year saw a huge surge in interest not just for stocks, but junk bonds, the high-yielding debt of less-than stellar companies. About $20 billion flowed into junk-bond funds in 2003, according to AMG Data -- more than the $16 billion that went toward investment-grade bond funds and more than double the $8 billion that went into junk in 2002.
As the money's flowed in, junk bond prices have rallied, pushing the spread between junk-bond yields and comparable Treasurys to the lowest level since Sept. 2000, according to Standard & Poor's.
Those lower yields have provoked a flood of new issuance. There were 515 junk-bond deals last year, according to Merrill Lynch, raising $141.1 billion. That's the most new issues since 1998 and the most money raised ever.
Investors' newfound love of high-yield bonds has much to do with the big moves we've seen in some of the riskiest stocks. Remember that a year ago many companies were priced to the point where buying their shares was basically a bet on whether they would survive or not. And the reason their survival was in question was that there were serious questions of whether they would be able to pay down the debt they had coming due.
The rally in junk bonds meant these companies could shore up their balance sheets. The possibility of extinction was skirted and share prices soared.
Yet investors would be wise to be wary, point out ING Aeltus strategists Ken Monaghan and Paul Ross in a recent note. We've seen yield-hungry investors provoke booms in junk-bond issuance before, in the late 1980s and again in the late 1990s. This did not end well -- many of the companies that the market extended credit to went belly up.
"Today, as bond buyers search in this period of very low interest rates and tight credit spreads for every additional basis point of yield they can find, market participants seem to be ignoring the lessons that were learned in prior bust periods," wrote Ross and Monaghan. "By ignoring those hard learned and expensive lessons, such investors are sowing the seeds of future defaults."
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