This year will be remembered for many things, most of them negative, brutish and just plain ugly. But 2008 will likely to go into the history books for other reasons, too, including a year that extended extraordinary gifts to strategic-minded investors. No less extraordinary will be the dearth of investors willing or able to accept the gifts from the financial gods.
So it goes in the money game. When prospective returns–long-run prospective returns–are thin, the crowd can’t get enough. At the other extreme, when risk premia is soaring, Mr. Market finds few takers. All the more so when fears of depression are swirling about.
Consider the chart below, which is but one example of the astonishing repricing of risk now underway. The recent spread in junk bonds over Treasuries is currently at levels last seen, well, almost never, at least since the modern notion of high yield bonds as an asset class was minted in the 1980s. Today, the asset class can be had at a yield spread of nearly 1,700 basis points over a 10-year Treasury yield. For reasons that need no explanation, there are few takers, which is one factor for why the spread’s so high. By comparison, in June 2007, the spread was compressed at one point to less than 260 basis points, a level that investors were happily accepting.
There are, of course, many reasons for shunning such rich spreads, just as there were many reasons for accepting the narrow spreads in June 2007. Indeed, juicy yields invariably come prepackaged with economic contraction and higher rates of defaults in the junk bond universe. They don’t call ’em junk for nothing.