Via Pater Tenebrarum of Acting-Man blog,
The WSJ asks whether junk bond investors have 'garbage for brains'. The short answer is probably yes. They do it every time – i.e., they buy more junk debt than ever at precisely the riskiest points in the cycle. Naturally this can go swimmingly for a good while, but as a general rule of thumb it is far better to buy such risky paper when the compensation one gets for taking the risk is actually adequate. It certainly isn't adequate at the moment, and yet, junk bond issuance has reached a new record high this year.
HY Spreads appear near their long-run average (though obviously well off cycle tights)...
but leverage is rising rapidly once again...
and all we have done is extend/roll maturities...
In spite of investors' bitter experiences with such exuberance, the cycle repeats over and over again. The driving force behind it is the central bank's easy money policy – which brings the sugar highs of today, but also the hangovers and steep losses of tomorrow. The WSJ gives us a little reminder of a similar episode that occurred in the distant past:
“Consider the wise words of Jules Bogen, editor of The Journal of Commerce, who explained the infatuation of individual investors with junk bonds this way:
The extreme easy money policy of the past few years has tended to drive down sharply the yields of the highest grades of bonds as financial institutions, particularly banks and insurance companies, have sought to obtain desired investments from the limited available supply. As a result, individual investors, accustomed to 5 and 6 per cent yields or more from their bonds, have had little incentive to purchase these high grade new issues.
Pause for a moment and let this sink in: Bogen wrote that passage in the March 1938 issue of the Journal of the American Statistical Association.
The markets have seen this movie before – long ago.
That doesn’t mean the movie is going to have a happy ending this time. But who is acting irrationally? When the Fed gives individual investors little choice but to take extra risk, whom should pundits point their fingers at? The investors? Or the policymakers?”
That is indeed a good question.