By Susan C. Walker Fri, 08 Oct 2010 14:45:00 ET

• Junk debt prices climbed to 100.115 cents on the dollar yesterday, the highest since June 2007, before record defaults on subprime mortgages sparked the worst financial crisis since the Great Depression.… (9/17) 

• Two years after the bankruptcy of Lehman Brothers Holdings Inc. caused credit markets to freeze, investors are embracing bonds backed by loans to consumers with weaker credit scores as yields approach all-time lows. Issuers have sold $4.4 billion of bonds tied to subprime auto loans this year, more than double the amount arranged in 2009.... (9/16) 

The public always does the wrong thing. Investors have gone from the frying pan (the NASDAQ in early 2000) into the oven (real estate in 2006) into the steamer (the Dow in 2007) onto the grill (commodities in 2008) and now into the fire. Each time, they are sure that their decision is sound. But once again, it is not.

Remember in 1999-2007, when stock buyers were sure it was “all about incremental earnings”? The same belief held in 1927-1929 (see chapter 13 of Market Analysis for the New Millennium), and both times it devastated investors. Now it’s all about “incremental yield,” with no regard whatsoever for the safety of principal. Bond investors, to put it bluntly and literally, are out of their (rational) minds, as much as they were on stocks and subprime debt in October 2007, the month of the all-time high in the Dow. By 2016-2017, the issuers of today’s high-yield bonds, and even today’s A and AA bonds, will almost certainly be in default across the board. When pessimism finally overwhelms the financial markets, both the principal and interest on these bonds will become unpayable.

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