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The Merrill Lynch High Yield index declined to a yield of over 20%, as of yesterday, to the surprise of almost nobody. In a market where the spread between agencies and treasuries is still over 160 basis points there is no chance of finding buyers for paper that actually has investment risk. I read a book once that compared arbitrage to picking up nickels lying on the ground while trying to dodge steamrollers –this market feels more like the ground is covered in silver dollars and everyone has their arms in casts.

Traditionally the order of risk dictates that capital flows as follows: arbitrage, relative value and then directional. The theory goes that, as capital seeps into the markets, it tends to pool in the lower ground first picking off attractive riskless (or risk defined) spreads. Therefore by extension lower rated paper shouldn’t rise until after arbitrage spreads begin to contract - In other words only when sufficient liquidity returns to the market to take out low hanging fruit will investors start to focus on individual corporate risks and actually figure out which ones are worth buying.

Until then it’s all just junk.

Andrew Barber