Here in the late summer of 2020, quite a few corporations are in a precarious financial position.
Investing in the debt of "speculative-grade" corporations brings elevated risk.
An August 31 article from the Hill discusses what to expect in the months ahead. Here's an excerpt:
There is a growing gap between what markets are expecting and a likely wave of defaults among struggling companies before summer 2021, according to an analysis by S&P Global published Monday.
The report by [the] head of S&P Global Ratings Performance Analytics, found that the dire state of the U.S. economy suggests a higher rate of defaults for what are known as speculative-grade companies. His analysis concluded that between this past June and the same month next year, defaults in that sector would rise from 5.4 percent to 12.5 percent.
The baseline scenario, which would see 229 speculative-grade companies default, involved a range of possible outcomes, from as few as 74 defaults to as many as 284.
"This historically wide range of possibilities reflects the growing divergence between market expectations of future defaults and those implied by credit and economic fundamentals during the COVID-19 pandemic and resulting stimulus measures," said [the head of S&P Global Ratings Performance Analytics].
The analysis went on to say that markets may be too optimistic and aren't accounting for companies getting by on cheap, borrowed money in the short-term that are ultimately facing solvency problems.
A "wave of defaults" would not surprise Elliott Wave International's analysts. Indeed, Robert Prechter's 2020 edition of Conquer the Crashed warned readers to prepare.
Let's take a look at two quotes from that "must read" book. Here's the first:
Consider that very little of total global debt is AAA. Most of it is graded much lower. This fact portends a slew of defaults from even a modest rise in interest rates coupled with an economic contraction.
This second quote from Conquer the Crash 2020 discusses the allure and dangers of speculative-grade bonds:
When rating services rate bonds between BBB and AAA, they imply that they are considered safe investments. Anything rated BB or lower is considered speculative, implying that there is a risk that the borrower someday could default. The lower the rating, the greater the risk. Because of such risk, Wall Street, in a rare display of honesty, calls bonds rated BB or lower "junk." They have "high yields," though, so people buy them. Lately, they have been craving them. In recent years, most new issues have been of BBB grade.
Low ratings compound the risk to principal. In a bad economy, issuers of low-grade, high-yield bonds find it increasingly difficult to meet their interest payments. The prices of those bonds fall as investors perceive the increased risk and sell them. The ultimate result in such cases is a low or negative total return. If the issuer defaults, your principal is gone.