Repetition is NOT Flattery

History has a nasty way of repeating itself, just when it’s least convenient.

Corporate profits have been strong. So strong, in fact, that they’ve attracted a lot of interest. Marginally profitable companies have been expanding, borrowing money and building out their businesses to capture these margins.

With unemployment high, labor costs have been low. And with interest rates down, lots of companies have been able to borrow and quite reasonable rates. In the past, it might have cost 13% for a large speculative bond issue to get sold. Now single-B issuers can float bonds at 8.5%. Since March 8, some $70 billion in junk bonds have been issued—the largest eight-week total on record.

But when everybody jumps into the pool, there’s not much space left to swim. Profitable sectors attract competition. This forces prices down and bids up the cost of labor, materials, and capital. This compresses margins, and weaker companies fail.

We’ve seen excessive issuance before, and it often ends in tears: biotech in the late ‘80s, dot-coms in the late ‘90s, telecoms in the early 00’s, and of course junk mortgage bonds in the mid-to-late ‘00s. This time we’re seeing an entire segment go nuts, rather than just one sector. But it bears repeating: excessive borrowing rarely ends well.

Maybe it’s really different this time around. But history has a nasty way of repeating itself.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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By | 2014-09-05T18:48:47+00:00 May 3rd, 2010|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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