The Rise of Junk
The great bear market rally of 2009 roars on today. Traders are still pumped about the surprisingly sweet start of earnings season last week. And with no economic data to speak of and a continually falling dollar, we can hardly blame them for “letting it ride” another day in stocks. The Dow opened up about 0.5% this morning with the S&P close behind. In fact, the Dow reached a fresh 2009 intraday high this morning and is steadily approaching every newspaper’s favorite “Dow 10,000!” Heh, though “Dow 10,000 Again!” just isn’t as exciting for some reason.
At the risk of raining on this parade, we add that this incredible rally over the last six months still pales in magnitude to the bust that preceded it. Just two years ago last week, the Dow hit its record high of 14,164. Caveat emptor.
“’Junk stocks’ have dramatically outperformed the broad market since the bottom in March,” notes Dan Amoss. “There’s a reason that junk stocks — stocks in which total debt is three, four or five times the value of equity — have rallied so sharply. Written off as imminent bankruptcy risks, the market left these types of stocks for dead, assuming that equity value would be wiped out in any balance sheet restructuring scenario. But the credit markets have thawed enough to allow most of these stocks to hang on a little longer in exchange for refinancing debt at much higher interest rates.
“Car rental stocks are classic junk stocks — especially in protracted periods of depressed consumer and business travel. These companies operate with massive debt loads in a brutally competitive, commodity business. They’ve all been cutting employee headcount and car fleets at incredible rates in order to stem losses.
“Now the car rental companies are adding mostly ’risk cars’ to their fleet. These cars are bought without the security of repurchase agreements, so they will be sold in the future into an uncertain used car market. This gives car rental companies more control over the length of time they own the vehicles, but it’s also transforming their balance sheets into speculations on the health of the used car market. If used car market values soften, then the car rental companies have to either accelerate their depreciation expenses or risk taking capital losses upon disposal.
“All of the car rental stocks were left for dead in early 2009, because it was doubtful whether they could renew the billions in financing commitments for their gargantuan fleets. The car rental business, in my view, is a dinosaur left over from the era of cheap credit and steadily growing business and leisure travel. In the future, we can expect to see an overlevered, capital-intensive set of competitors battling it out for scarce business. This may be good for consumers, but it’s terrible for owners of car rental stocks.”
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