Weary Investors Battle Confusion, Hang On to Hope
October 9, 2008
How are you? I say. Is that a rhetorical question? the investor says. And so begins one of the conversations I had with portfolio managers this week.
We all know its bad out there. Really bad. The worst it has been in almost forever. What we dont know is: Could it get worse? When will it get better?
For high yield debt investors, spreads look incredible, junk bonds have widened out beyond 1300 bps. However, everyone agrees that defaults will rise, on a large scale beginning in 2009 and going on into 2010, according to the rating agencies.
And this dilemma creates a sense of uncertainty, and leaves some holding on to more cash than theyd like to. The fact that weve entered an environment where most traditional analysis falls short only adds to the confusion, investors say. So much emotion and fear permeate the market right now, the analytics dont really help to explain whats going on.
At some point, you want to be buying high yield, especially when spreads are towards 1000, a Minneapolis-based junk bond investor told me. Part of me says maybe its time to jump in. But [something] that has held me back, at least during the last two weeks, is that historically spreads havent peaked until default rates have peaked and/or until after a recession has ended. That would lead you to believe that maybe weve got quite a ways to go yet.
So whats an investor to do?
For a longer-term investor, it makes sense to stay invested. If were no good at timing a market top, what makes us think wed be any good at calling a market bottom? a Boston-based investor said. And getting back in when the market does turn aroundand hopefully it will turn around quicklyif youre on the sidelines with cash you will miss the first 10 or 20 or 30 percent returns.
To address the dilemma of where and when to put money to work, some investors seem to be employing the simple tactic of leaping for the higher rungs on the credit quality ladder. In other words, because of the impending default cycle, now probably wouldnt qualify as a great time to buy triple-Cs aggressively. But double-B names, or maybe high single-Bs, could offer at least a somewhat safe bet. As one portfolio manager put it: You go with the names you think will be around.
In the end, it comes down to trusting that the market will rebound, as it always has. At some point there will be a great bull market in high yield, the Minneapolis-based investor said. I just dont know when.