Despite extremely low interest rates, it's still pretty difficult for ordinary Americans to get the money they want by taking on debt. For corporations, though, the credit markets have been a gold mine, and companies continue to take advantage of debt financing for a variety of reasons. Although some of those companies are using debt for perfectly reasonable purposes, what others are doing with the money raises some questions about whether we're returning to some of the troubling conditions that prevailed before the financial crisis -- and arguably helped to cause it.
The market that would not quit
Even as stocks took a breather in October, the bond market continued to post impressive gains. Through 10 months of the year, one index of high-yield corporate bonds is up more than 13%, rivaling the year's gains for the stock market. Although the deal between Sprint (NYSE: S ) and Japan's Softbank had a huge impact on the former's bond prices, arguably skewing the high-yield index, several industries contributed to the index's strong performance in October. Moreover, other indexes measuring investment-grade corporates, European high-yield debt, and emerging-market bonds gained between 1% and 2% for the month.
Ordinarily, you'd think that gains like these would suggest a lack of supply. Yet nothing could be further from the truth, as more than $40 billion in dollar-denominated high-yield debt hit the market in October, bringing year-to-date figures to an already record high of $288.5 billion, topping 2010's previous record full-year results.
Get while the getting's good
Much of the credit market activity you're seeing now has been driven by extremely low interest rates. Plenty of companies have taken advantage of cheap financing, with Caterpillar (NYSE: CAT ) among the latest companies to issue bonds. On bonds that the construction machinery giant issued just a few months ago, prices have risen sufficiently to suggest that the company could get yields on its new bonds that would be between a quarter-point and a half-point cheaper than its outstanding issues. With a desire to provide loans to customers through its financing arm, Caterpillar's move makes a lot of sense for the company and investors alike.
But some investors are growing concerned about other debt issuance. For instance, private equity company Carlyle Group (Nasdaq: CG ) is among institutions that are having the companies they own within their private-equity portfolios issue debt in order to raise money that the companies then use to pay dividends to the private equity firm owners. With the rising popularity of special bonds that allow companies to make interest payments in the form of further debt rather than cash, including bonds that Carlyle-owned Pharmaceutical Product Development issued in late October, private equity companies are getting themselves paid while leaving companies under heavier debt loads -- which public investors may end up bearing when private equity firms choose to have those companies make initial public stock offerings down the line.
The popularity of bond ETFs is also having a supportive impact on the bond market. With SPDR Barclays High-Yield Bond (NYSEMKT: JNK ) offering exposure to corporate junk bonds and the closed-end Templeton Global Income (NYSE: GIM ) owning international sovereign debt, it's easier than ever for investors who once would have found the bond market too difficult to trade in instead to buy ETF shares. Especially for index-driven bond ETFs, the resulting spikes in demand for certain bond issues have the potential to create imbalances in the market.
Bond-market bears have cited factors like this for years in their arguments that interest rates need to rise and bond prices must fall. So far, those bearish predictions have been dead wrong, as the Federal Reserve's commitment to low interest rates for as long as they take to have the desired impact on the economy continues to support bonds.
Clearly, cheap financing benefits borrowers. Rather than taking the other side of their bond selling, investors should consider whether joining companies by buying their stock after a debt offering will let them share in the spoils of their plundering of the bond market.
For Caterpillar, cheap financing could help drive growth even in a slowing global economy. With its quality products, extensive service network, and unparalleled brand strength, Caterpillar has solid competitive advantages. But is Caterpillar's stock a buy right now? Read all about Caterpillar's strengths and weaknesses in our brand-new report. Just click here to access it now.