Two Brokerages Foresee More Corporate Bond Woes
Whether called “blowups,” “bombs” or “land mines,” corporate credit problems are causing broad pain in the U.S. corporate bond market, and the worst may not be over, two big Wall Street brokerages say.
Merrill Lynch & Co. and Salomon Smith Barney said blowups resulting largely from disappointing earnings or sales, real or threatened, show investors punishing bonds much as they have stocks--with zero tolerance for mishaps.
“The random nature of the credit events that have plagued the credit market all year equates to a rise in overall market risk,” wrote Merrill Lynch.
Both brokerages, in reports issued Friday, said more woes are probably in store as the economy slows. But that may not be reason to avoid corporate bonds altogether, the firms said.
Other bond experts, such as Pacific Investment Management bond guru Bill Gross in Newport Beach, say they are staying away from corporate issues, period.
But “you have to be a little more selective than to simply say you don’t like the corporate bond market,” argued Eli Lapp, senior vice president and corporate bond strategist at HSBC Securities Inc. in New York. “You cannot taint the entire market with a negative brush because of blowups.”
Blowups are corporate bonds that quickly plunge in value, often so much that traders quote them by price--like junk bonds--rather than by spread, or their yield premiums over benchmark U.S. Treasuries of similar maturity.
One example: Xerox Corp.’s 5.875% notes maturing in 2004. The troubled copier maker, expected to outline a turnaround plan today, still carries investment-grade ratings, but its notes trade at just 75 cents on the dollar.
Merrill Lynch identified 27 blowups this year, comprising 3.1% of its main corporate bond index and affecting $32.3 billion of bonds. These bonds fell an average 31% in value. In terms of the index itself, those losses sliced nearly one percentage point off the total return (price change plus interest earned). It is up 6.07% through Friday.
Meanwhile, using different methodology, Salomon found 60 blowups this year. So many different corporate bonds have blown up that few big bond investors could have avoided owning one, it wrote.
Bonds often sink for fundamental reasons. Retailers with falling profit margins and sales, such as Dillards Inc. and J.C. Penney Co., have seen their bonds blow up. So have finance companies with weaknesses in loan portfolios, such as Conseco Inc. and Finova Corp.
Many bond pros caution that the market may not be at bottom.
Stock market volatility, falling corporate liquidity, rising energy prices and the strong dollar leave Merrill Lynch cautious. It said investors should favor bonds from industries such as aerospace or oil and gas.
