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Saturday, October 30, 2010 2:56 AM

Mad Dash Into Junk Sets October Record

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The mad dash into junk bonds continues. Please consider Junk Sets October Record, Mortgage Bonds Rally

Sales of junk bonds in the U.S. set a record for October as returns topped investment-grade debt and more borrowers were raised than cut. Government-backed mortgage bonds may beat Treasuries by the most in at least 10 years.

Fortescue Metals Group Ltd. and Calpine Corp. led speculative-grade companies issuing $33 billion of debt this month, according to data compiled by Bloomberg. The notes have gained 2.32 percent on average in October, compared with a loss of 0.16 percent for high-grade securities, Bank of America Merrill Lynch Index data show. Not since March have high-yield, high-risk securities outperformed by such a wide margin.

Investors have driven relative yields down to the lowest in five months on confidence the Federal Reserve will flood the economy with money, allowing the neediest borrowers to access capital and refinance debt. The rally is robust enough to extend into next year, said James Murren, chief executive officer of Las Vegas-based casino operator MGM Resorts International, which sold $500 million of notes rated CCC+ on Oct. 25.

“The bond market will get better,” Murren said yesterday in an interview at Bloomberg headquarters in New York. “People are going to start to have a more positive outlook toward 2011. They’re going to be searching for yield and they’re going to go down the rating scale and that’s going to benefit companies like us.”

U.S. junk bonds have gained 14.4 percent this year, compared with the record 57.5 percent in all of 2009. The 1.96 percent increase this month in the Bank of America Merrill Lynch Global High Yield & Emerging Markets Plus index exceeds gains on the Global Broad Market Corporate Index by 215 basis points, after outperforming by 233 basis points last month.

Global corporate bonds have lost 0.19 percent in October, after rising 0.22 percent in September and the worst performance since losing 0.4 percent in May. Year-to-date returns total 8.84 percent.
Lehman High Yield Bond ETF

S&P 500 Weekly Chart

Buy the Dip?

The last two downturns in January and May of 2010 were buying opportunities. Will buy the dip work next time? Fundamentally I see no reason it should, but that does not mean it won't.

I have been saying for 18 months that the stock market is unlikely to break hard as long as corporates are strong, but buyer beware, sentiment can turn on a dime.

Extreme Sentiment

We have a possible warning signal in that the corporate rally for the last two months has been US only.

We have another type of warning signal with the CEO of MGM Resorts International proudly proclaiming “The bond market will get better.”

Will it? He does not know, no one does. Moreover, I see no reason to think it will.

Finally, we have Richard R.S. Smith, head of high-yield capital markets at Royal Bank of Scotland’s RBS Securities unit touting “We’ve pushed many of our clients into what we view as a very attractive market from a refinancing standpoint. We think it’s going to continue as long as the U.S. government maintains a 10-year treasury rate below 3 percent.”

RBS just happened to pimp $500 million of MGM bonds rated CCC.

This is exactly the kind of sentiment it takes to make a top. However, please remember that sentiment, no matter how extreme, can always get more extreme.

Mike "Mish" Shedlock
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