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As junk bonds increasingly come back into vogue, some fixed-income observers caution that history could repeat itself in the high-yield bond market.
The worry is that investors may be as overconfident about the junk bond market as they were before the market crashed in the late 1980s.
"My concern is that the continued positive economic environment for junk bonds may create a euphoric atmosphere similar to the 1980s," Leo O'Neill, president of Standard & Poor's Corp. ratings group said. O'Neil made his remarks at Standard & Poor's fourth annual State of the Credit Markets Report.
Junk bond volumes have risen steadily in recent years, clocking in more than $59 billion in new issuance in 1993, according to Standard & Poors. That figure is leagues above high yield volumes of $38 billion in 1992, $10 billion in 1991, and less than $1 billion in 1990.
Junk bonds now account for a substantial source of funds for corporations, O'Neill said, voicing concern that some investors may get in over their heads. While he does not see problems near-term, he added the warning flags should be flying.
Fixed-income market players generally agreed yesterday that the resurgence in high-yield debt instruments warrant caution and that market participants should recall the lessons of the 1980s. However, most agreed that careful research and smart positioning can alleviate much of the risk factor.
For the first time since 1980 in the U.S. corporate sector and 1986 in the U.S. municipal sector, rating upgrades outpaced downgrades last year, O'Neill said. Standard & Poor's attributed the change to the most favorable interest rate environment in a generation and continued belt tightening among corporate and municipal issuers.
Despite the improving outlook, Standard & Poor's noted that as U.S. industrials and service firms reinvigorate themselves in an expanding economy, they should be mindful of recent lessons: size does not equate to strength; perceived synergies do not automatically create products and services consumers need, or even want; and acquiring companies using a surfeit of debt may leave the combined operation too weak to confront unexpected contingencies.
Among U.S. corporate issuers there were 343 upgrades, compared with 263 downgrades, O'Neill said. However, the dollar volume of downgrades outpaced upgrades - $243 billion versus $130 billion - because...