Most of my clients own some bonds in one form or another and the issues of credit quality and the credit cycle are always worth staying informed about.
The Credit Cycle
Most credit cycles have three distinct stages:
1) Time to clean – Corporations will use this stage to clean house, improve balance sheets and get healthy. Risks related to default should begin to lessen. The overall economy can contribute to how long this stage lasts.
2) Stability – Most balance sheets can only improve so much and the Corporation will likely reach a quality plateau. Stability results and this stage can last for quite some time. I believe this is where corporate America is now.
3) Here We Go Again – The typical long length of the second stage can cause the Corporation to become lax and the broader economy will likely go through its own period of deteriorating conditions putting further pressure on corporate bond issuers to begin anew.
Recognizing where we are in any cycle can be useful to investors as it takes some of the uncertainty of investing away. Of course, not all cycles are the same and surprises can come but, as an advisor, I like to remind myself and you of where we likely are.
Until next week,
Susan R. Linkous
Terms to Know
Credit quality is one of the principal criteria for judging investment quality of a bond. As the term implies, credit quality informs investors of a bond’s credit worthiness or risk of default.
High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB or above. They generally should be part of a diversified portfolio. The market value of corporate bonds will fluctuate and, if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
The opinions expressed above are just that, opinions. Please seek advice before investing and understand that past performance is no guarantee of the future.