The Wall Street Journal Interactive Edition -- March 10,

1997

Junk Bonds Are Acting

As Exuberant as Stocks

By GREGORY ZUCKERMAN

Staff Reporter of THE WALL STREET JOURNAL

Don't look so smug, bond investors. Alan Greenspan was

talking to you, too.

While exuberant stock investors seem to be taking a lot of

heat from the chairman of the Federal Reserve these days,

Mr. Greenspan had sharp words for the bond market as well.

In his Feb. 26 congressional testimony, the chairman noted

that an overly optimistic attitude "has become especially

evident in quality spreads on high-yield corporate bonds."

Yet, junk-bond prices remained stable following the

chairman's remarks, and even though they have shown some

subsequent weakness, they haven't fallen to the extent of

Treasury and emerging-market bonds. Money flowing into

junk-bond mutual funds slowed last week, but inflows still

grew on a net basis.

Indeed, investors in high-yield corporate bonds and junk

issues are being paid record-low premiums for the risk they

are taking when compared with a safe investment in Treasury

bonds. The historically narrow 3.25-percentage-point gap

between Treasury yields and junk-bond issues remains near

record levels. In the past four months alone, the gap has

shrunk by a full percentage point. And the spread between

corporate bonds and junk bonds is just over two percentage

points, compared with a traditional gap of three percentage

points.

Slight Unease

On Wednesday, Mr. Greenspan seemed to retreat a little from

his earlier stern warnings to stock investors, conceding

that "if profit margins continue to rise as analysts on Wall

Street expect," the market apparently is properly priced.

But he made no equivalent concessions to the high-yield

market, leaving some experts a little uneasy.

"The last time there was focus from the government on the

market was in 1990, when the talk was about laws against

junk bonds," notes Bob Kricheff, the head of high-yield

research at Credit Suisse First Boston.

Mr. Greenspan "focused specifically on high yield, and some

were surprised by that" since the Fed usually abstains from

commenting on bond prices, adds Martin Fridson, who heads

high-yield research at Merrill Lynch.

But other analysts weren't so surprised that the market

shrugged off Mr. Greenspan's warning.

"The market read his comments and glossed over them," says

Phelps Hoyt of KDP Investment Advisors in Montpelier, Vt.

"The view is that he can say what he wants to, but the

market trades on the economy's fundamentals, and if they're

strong there's no reason for spreads to widen."

What's more, analysts expect junk-bond prices to remain

stable despite the Fed chairman's remarks. For one thing,

the quality of companies issuing high-yield debt has never

been better. While bonds financing mergers and acquisitions

are on the rise, little of the new debt is being issued for

leveraged buyouts or by overleveraged companies struggling

to stay afloat, as in years past.

Better Ratings

In fact, five years ago 34% of the junk market was rated

double-B or better, but about 43% is in that upper-tier

category today. At the same time, companies rated triple-C

or below represent just 3% of the market, down from 8% at

the end of 1992. Defaults have fallen to a record-low 1.3%

of high-yield issuers from 3% just over a year ago.

The market's technical indicators also look robust. Money,

including additional funds from pension and retirement

plans, is finding its way to the market like never before,

sending issuance and inflows to all-time highs. Even if the

Federal Reserve executes an interest-rate increase, some

analysts suggest it may help rather than hurt high-yield

bonds by cooling off a strong economy and postponing the

threat of a recession, one of the worst fears for junk-bond

investors.

At the same time, the rush of foreign funds to the U.S. bond

market searching for better returns could be accelerated by

an interest-rate rise, and some of that capital inflow may

find its way to the junk market. Since junk bonds are less

interest-rate sensitive than other fixed-income instruments,

some bond and stock investors may choose to seek refuge in

high-yield bonds in the case of an interest-rate move.

Given those factors, "the spread is right where it ought to

be," Mr. Fridson says.

Grabbing for Yield

"The prices are appropriate because the economy is more

stable, and if there is a low risk of recession junk bonds

should be at low yields to Treasurys," says Willam Dudley,

director of economic research at Goldman, Sachs & Co. "If

interest rates are raised, it would be a bit of a negative

because it raises the risk of recession. But if it helps

extend the expansion, it's a healthy thing for junk bonds."

Still, junk-bond investors are clearly stretching for yield,

and there are signs of exuberance. Investors are

increasingly willing to accept higher risk by purchasing

more junior securities, though not yet to the extent of the

late 1980s. For example, there has been a surge of issuance

of a type of junk bond called "exchangeable preferred

securities," which are equity securities structured to look

like bonds and exchangeable into debt, but subordinate to

other bonds.

Mr. Greenspan's comments may be best seen as a warning of a

market top, rather than a forecast of a sudden drop in

high-yield bonds. "Spreads are at historical levels, and our

firm has a neutral to slightly negative bias so we sort of

agree with Greenspan, but it's not a big emergency," Mr.

Hoyt says.

Friday's Market Activity

After trading lower Thursday ahead of the February

employment report, Treasurys rebounded Friday, as the Labor

Department release contained little evidence that wage

pressures were building.

[Bond Yield]The benchmark 30-year Treasury bond rose 26/32

point, or $8.12 for a bond with a $1,000 face

value, ending at 97 1/2 . Its yield, which moves in the

opposite direction of its price, fell to 6.81% from 6.88%

Thursday.

Prices fell initially on news that February payrolls grew by

339,000, the largest monthly gain since May of last year.

The figure exceeded the consensus forecast of 250,000. But

the market recovered quickly because, despite the payroll

surge, average hourly earnings rose only three cents to

$12.09, a penny below forecasts.

"We haven't seen any worsening in the wage picture out of

this number," said Mary Dennis, senior market strategist at

Credit Suisse First Boston. "It didn't change anybody's

picture about the Fed."

Market attention now turns to several other monthly economic

reports, including retail sales to be released Thursday and

the producer price index on Friday.

Elsewhere, municipal bonds were quoted 1/8 to 3/8 point

higher in price, pulled along by the rally in Treasurys.

Among active issues, in Alabama, Jefferson County's 5 3/4 %

bonds due 2027 were 3/8 of a point higher at 98 7/8 to yield

5.8%.

The municipal sector is expecting several sizable offerings

this week.

The largest may be $709 million in Puerto Rico

general-obligation bonds, brought to market by a Lehman

Brothers group. Puerto Rico issues usually attract ample

buying because they bear interest exempt from federal, state

and local taxes throughout the U.S.

Also scheduled to be priced are $432 million of Alaska

Housing Finance Corp. revenue bonds by a Lehman Brothers

group and $160 million of California Housing Finance Agency

revenue bonds by a Goldman, Sachs & Co. group.

Among the day's corporate issues, Olympic Financial Ltd.

sold a $300 million junk-bond offering, while a unit of bank

holding company Riggs National Corp. priced $200 million of

30-year trust preferred securities.

In trading, Marvel Holdings Inc. debt securities gained a

point in price as they rallied on news that Ronald

Perelman's Andrews Group, which owns 80% of Marvel equity,

terminated a restructuring plan opposed by bondholders.

Marvel discount notes due 1998 were up one point at 20.

-- Ross A. Snel and Candace Cumberbatch

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Reserved.