2006 was a funky year for investing as a lot of "rules" no longer seemed to apply.
One such rule has been the relationship between bond prices/rates and risk. As more and more money has been flying around the markets, the premium investors demanded for riskier bonds has all but disappeared.
I am not sure that change is a good thing for anyone (except risky companies that need to borrow cash) but this article indicates how large of a problem this has become.
Junk Turns Golden, But May Be Laced With Tinsel
January 4, 2007
Wall Street Journal
"People forget the bad times and remember only the most recent good times, and I fear that's the case right now," says Edward Altman, a finance professor at New York University who was one of the first academics to study junk bonds in the 1980s.
Ratings services like S&P, Moody's Investors Service and Fitch Ratings assign a range of rankings to companies based on their perceived ability to repay debt. S&P's rankings go from triple-A -- rock-solid companies like General Electric Co. that are sure to pay it off -- to single-D, which are already in default. Companies with the highest credit ratings pay lower interest rates.
Bond investors make money on interest payments. They can also make or lose money on the underlying value of the bond, which goes up if the perceived risk of default goes down and vice versa.
These days, triple-A companies are nearly extinct. Just six nonfinancial corporations bear the label.
Now the common currency is single-B, a level one step below the official junk standard of double-B. Single-B companies have grown to 42% of the 2,000-odd nonfinancial, nonutility corporations tracked by S&P today, from 7% in 1980.
"Most people think they are smart enough to get out when they should," says Mr. Riccio of S&P. "The question is who will be left holding the bag."
