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No. of Recommendations: 2
the Fed's ZIRP and general money supply expansion ... is distorting the markets so badly that getting refinanced even for a very risky business is not as hard as it should be. So the concept of risk is, again, distorted. Lots of companies that probably should go under are staying afloat thanks to cheap and/or available credit. "


Shrewd point and the same one others are making. E.g., Booth estimates 20% of US companies are "zombies" and are being kept alive by the Fed. But now consider the risk-assessment task from the point of view of a risk-adverse value investor. Let's say someone's bond offers an above-the-current-market yield, but a yield that's lower than what used to be available on no-nonsense, double BB's, and the issuer's financials suck. Does it make any sense to buy their single-B debt --and more likely triple-CCC trash-- as an "investment", as opposed to a purely speculative, second-order bet?

I.e., the thinking would have to go like this. "This company is a dead man walking whose debt makes no sense at all to buy other than the possibility the Fed won't let the bonds fail."

The Fed or not, you can assume default-rates will increase going forward. So let's create a betting table based on 5-yr, historical default averages, which Moody's says runs something like this. Triple-AAAs have negligible defaults. AAs, maybe 1-2%. As, maybe 3%. BBBs, maybe 8%. BBs, maybe 13%. CCCs, maybe 21%. CCs, maybe 34%. Cs, maybe 55%. Those aren't their exact numbers, but close enough, and "Yes" the real numbers are pretty close to a Fib series. To build in a margin of safety, let's increase the predicted defaults for each rating by one notch, as well as note that triple-BBB ratings have exploded in number relative to historical distributions. In fact, most of the group would be downgraded to 'junk' if the rating agencies weren't being leaned on by the Fed. That's not a publicly known fact. But that's what's happening.

Now, here's our betting table. You should expect roughly 1/3 of every triple-BBB you buy to default. You should expect roughly half your double-BBs to default. You should expect roughly 90% of anything rated single-B or lower to default.

Those are horrible odds. But consider this. The right/wrong ratio of a classic, trend-following, stock trading system is about 35/65. In other words, you can expect 2 out of every 3 stock buys to lose money. Why can trend-followers make money with those (or even worse) odds ? Because they chop left-hand tails and let winners run. Now apply that game to bond investing, which is what I did for lot of years and made good money. Upper-tier credits don't need to be gamed. It's the lower-tier stuff that requires two things: prudent positions sizes and industry diversification. ("Buy widely; buy small.")

Right now, not enough junk is being offered to play that game. So I pass.

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