(FORTUNE Magazine) – By now the notion that the major U.S. automakers are in tough shape financially--wedged between their own crushing obligations to retired union workers and ever-increasing competition from abroad--is no surprise to investors. So while the decision by Standard & Poor's on May 5 to downgrade $453 billion of outstanding General Motors and Ford Motor debt to junk status came a little earlier than most observers expected, it was hardly a shock. "It was the biggest nonevent since Y2K," says Jeffrey Rosenberg, head of credit strategy at Bank of America.

It's still not clear whether Ford and GM bonds will end up as pure junk. On May 12, Moody's followed S&P's lead, downgrading Ford to its lowest investment-grade rating, one notch above junk level. Fitch, the third major rating agency, has yet to act. But even without a flood of auto company debt to digest, the high-yield market is facing some serious challenges. After returning 28% in 2003 and 11% in 2004, the Merrill Lynch high-yield bond index has fallen 2.7% thus far in 2005. And with rising interest rates pushing up the cost of borrowing, new deals are being postponed. Plus, the credit quality of new issues that do make it to the market is getting worse. In 2003, about 31% of new issues were at the lowest levels of credit quality, B-- or CCC, according to S&P. Last year that figure reached 43%. In the first quarter this year, about half of all issues were at the lowest levels. Default rates, which have been at cyclical lows, have only one way to go. "We expect default rates to tip up in 2006," says Diane Vazza, head of global fixed-income research at S&P. Meanwhile, mutual fund investors have been heading for the door, cashing out $1.8 billion in April and taking $4.8 billion out of the high-yield sector in March, according to TrimTabs. All of which means that the junk-bond market is in for a bumpy ride.

So what's the best strategy for an individual investor? Even though the average junk-bond fund is yielding an enticing 7%, the risks seem to outweigh the rewards. So we wouldn't be adding new money right now. If income is your goal, you would do well to consider financially solid, dividend-paying stocks (such as the utilities mentioned in the previous story). And if safety is your priority, it might be best to stick with Uncle Sam. The ten-year Treasury may be yielding just 4.12%, but at least you don't have to worry about downgrades.

-- Kimberly L. Allers