Valuing bonds, dollar is crazy in mad world

Investors who own European corporate bonds have made more than 15 percent this year on a total-return basis, according to figures compiled by Deutsche Bank AG. Subordinated debt sold by financial companies has delivered more than 26 percent. In Europe's high-yield market, junk debt has returned a spectacular 67 percent.

You will struggle, though, to find anyone who trusts the rally. Too much money, with nothing better to buy, indiscriminately rushing back into the credit markets — that seems to be the culprit. Never mind that the default rate among high-yield companies in Europe reached 9.3 percent at the end of the third quarter, up from 6.4 percent in the previous three months, according to Moody's Investors Service.

The rating company is predicting speculative-grade bond failures will peak at 10.9 percent this quarter, before almost halving to 6 percent a year from now. That seems way too optimistic, given the economic carnage wreaked by the credit crunch on corporate creditworthiness.

You know markets have gone mad when corporate bonds promise equity-style returns. It can mean only one thing: Investors should brace themselves for the equity-style risk of losing all of their money, not the security of regular interest payments.

Currency Carnage

The Japanese economy has been a basket case for years, with a second-quarter gross-domestic-product performance that was downgraded to an anemic 2.3 percent pace from an initial 3.7 percent estimate. The U.S. economy, meantime, is lauded for its flexibility and endurance, as proven by its bounce out of recession to post 3.5 percent growth in the third quarter.

Nevertheless, the currencies of both countries currently seem yoked together in the hive-mind of the investment community. When risk aversion rises, the yen and the dollar climb, and we're told that investors are seeking the safety of havens. When risk appetite improves, the dollar and the yen both get trashed, unwanted and unloved. Moreover, the U.S. currency is now talked about as a carry-trade favorite, something you borrow because it's cheap and easy, and you want to invest somewhere more lucrative.

You know markets have gone mad when the yen is perceived to be a refuge and the dollar is the catalyst of choice for re- inflating a global bubble.

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