Equity investors beware: Last week, the yield on the Merrill Lynch High Yield Index II hit an all-time low of 6.84%. In plain English, that means junk bond investors are now willing to accept a lower yield than at any time in the past.
They may yet accept less: The market doesn't anticipate an interest rate hike before 2012. Inflows into junk bond funds in the first six weeks of this year already represent roughly half of the 2010 total -- and last year was a good year, with junk bonds returning 15.2% (Want some yield of your own? Dan Dzombak's thinks this high-yield dividend portfolio will beat the market).
Cheap money and risky assets
Does last week's milestone provide firm proof of irrational exuberance? No, but it should certainly raise investors' eyebrows – whether they invest in bonds or stocks. That's because one of the principal factors fueling the rally in junk bonds also propels stocks higher: Cheap money. Through its policy of zero interest rates, the Fed has decimated the opportunity cost of holding risky assets, intentionally spurring speculation.
The equity equivalent of junk bonds
In the equity world, the seven stocks in the following table look like the equivalent of junk bonds: They belong to businesses that have little or no competitive advantage or that are substantially leveraged, and they have experienced a big run-up in share price over the past 12 months resulting in valuations that look stretched. Not a reassuring combination of factors.
|
Company |
Forward P/E |
Total Debt-to-Equity Ratio (Latest Quarter) |
|---|---|---|
| Boyd Gaming (NYSE: BYD) |
249.0 |
223% |
| Ciena (Nasdaq: CIEN) |
157.7 |
905% |
| Clear Channel Outdoor Holdings (NYSE: CCO) |
168.3 |
94.7% |
| Safeguard Scientifics (NYSE: SFE) |
57.3 |
38.7% |
| Satcon Technology (Nasdaq: SATC) |
21.6 |
486% |
| Sirius XM Radio (Nasdaq: SIRI) |
38.7 |
1,550% |
| United Rentals (NYSE: URI) |
21.9 |
NM |
*As of Feb. 17, 2011, based on next 12 months' EPS estimate. Source: Capital IQ, a division of Standard & Poor's.
Know the shares you own
Let me preempt the critics: I'm not bashing Sirius XM or any other company, and I'm not part of a short-sellers' conspiracy. The satellite radio provider happened to be one of just 14 companies in the Russell 3,000 that showed up in my screen. Screens are a statistical tool and any one of the names in the table could be a false positive (or even possibly all of them) – but I'd require some convincing before owning any of these shares.
Between high-yield bonds and high-yielding stocks, we prefer the latter. The Motley Fool has identified "13 Stocks High-Yielding Stocks To Buy Today."
