Subject: [NEXTEL-1] WSJ.com - As the Credit Cycle Turns...The Worst May Be Over

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Date: Mon, 02 Dec 2002 02:02:42 -0500

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As the Credit Cycle Turns...The Worst May Be
Over

By JENNIFER
ABLAN

Welcome to the dawn of a new
credit cycle. After two years of record bankruptcies, a flurry of rating
downgrades and massive credit blowups, as highlighted by Enron and
WorldCom, the credit cycle is in the process of turning.

"We've passed the point of maximum risk," says Margaret Patel, who
manages the $3.5 billion Pioneer High Yield
Fund.

Moody's Investors Service provided some statistical evidence of that
last week. Its tally of the global default rate for speculative-grade
issuers fell to 9% in October from 9.5% in September, the eighth time that
the rate has declined in the last 10 months, with the trend expected to
continue.

Reflecting these improving fundamentals, the rally in high-yield "junk"
and corporate bonds continued and has shown no signs of abating. Indeed,
investors' fears of credit risk have diminished considerably, as the
economy continues to strengthen, evidenced by the stock market's rebound
and companies continued commitment to repairing their balance sheets.

And it appears that Corporate America also is beginning to share the
same confidence illustrated by investors.

The commercial-paper market, which has been dormant owing to the slump
in capital spending and M&A activity, has shown some signs of life.
Total commercial paper outstanding -- which is unsecured debt to be repaid
within 270 days -- rose $4.6 billion in the week ended November 20, after
rising by $12.4 billion the previous week.

The market has seen an increase in CP outstanding in three of the past
four months.

That's encouraging news, given that the market had been rocked by the
world's biggest bond investor, Pimco's Bill Gross, who prominently
questioned the top triple-A credit of General
Electric for relying too heavily on short-term debt on its books
earlier this year. (Top U.S. corporations have been curbing their reliance
on the CP market since then.)

But the woes in the credit markets didn't stop there: WorldCom's
bombshell certainly kept investors hypersensitive to deteriorating
finances.

Even Ford Motor, the biggest issuer in
the U.S. corporate-bond market, saw investors trade its investment-grade
bonds as if they were junk after concerns arose about the car giant's
credit quality (Current Yield, Oct. 14).

Conversely, the Ford crisis signaled the very bottom for this credit
cycle, according to some bond-market pros.

"I think when we look back on it, it'll probably be viewed that Ford was
sort of the 'last great challenge' that the short-sellers took on and
perhaps could not succeed in," says Tad Rivelle, chief investment officer
at Metropolitan West Asset Management.

He's referring to the fact that earlier this year, investors had
complained that short selling -- which attempts to profit from the fall in
the price of a security -- drove bond prices of already vulnerable
companies lower and their yields higher. That negative market, investors
asserted, provoked rating agencies to downgrade these companies' debt to
junk status -- below triple-B-minus or Baa3.

"Ford bonds didn't just keep falling and the rating agencies didn't
start downgrading," says Rivelle.

The psychology in the market seemed to change after "the dynamic didn't
unfold the way the shorts wanted to with Ford," he adds.

HSBC's announcement last month
that it was acquiring Household
International also boosted the tone in the corporate-credit
market.

Nevertheless, credit conditions have improved dramatically since
October.

"The next year, the risk-takers will get their turn," says Pioneer's
Patel, who has increased her high-yield fund's exposure to economically
sensitive industries that will benefit over the next year when the economy
fully recovers. Morningstar rates the Pioneer fund five stars, the
mutual-fund tracker's highest ranking.

While junk bonds have returned 6.2% in total returns since Oct. 31,
Patel believes there are more gains to be had in high yield.

Last week, the Merrill Lynch High-Yield Master II Index narrowed
two-tenths of a percentage point to stand at 8.76 percentage points over
Treasuries, down sharply from 10.37 points since Oct. 31, an astounding
15.5% tightening on a spread basis.

Patel says the Merrill Lynch index could narrow to 6.50 percentage
points over Treasuries.

However, Gregory Peters, credit strategist at Morgan Stanley, cautions
that junk bonds have seen prices soar too far too fast and that investors
aren't being compensated like they used to for the risk they are
taking.

As the above chart shows, the spread differential between the lowest
investment-grade credits and the highest-rated junk bonds has narrowed and
prices have jumped sharply.

In addition, Peters says while there are names, like Nextel
Communications, whose bonds
have soared on expectations that it will generate positive earnings, the
majority of credits that have seen their bonds rise will be losing money in
the next couple years, citing American
Tower and Amkor
Technology. "There still are risks out there," he says.

But historically wide spreads continue to attract investors.

"Can I find things that are too rich?" (that is, too low in yield and
high in price), asks Christopher Towle, partner and portfolio manager at
Lord Abbett. "I sure could. But I can still find bonds that are trading at
a discount that could move up. But you have to do your homework."

Investors seem to be on that page.

The Treasury market -- which had rallied strongly amid the deterioration
in corporate credits and the unrelenting pressure on stocks -- have seen
their yields back up again simultaneously with the rallies in the corporate
and junk debt and encouraging economic data.

The yield on the benchmark 10-year T-note settled Friday at 4.21%, up
from 4.18% one week earlier. The 30-year Treasury bond also firmed on the
week, closing Friday at 5.05%, up from 5.02%. Meanwhile, the yield on the
two-year note, the maturity most sensitive to expectations of Fed moves,
was virtually unchanged at 2.06%.

E-mail comments to
[email-masked]

Updated December 2, 2002

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