A flight to quality by investors has brought the raging bull market for high-yield bonds to a near standstill this month.
In the last two weeks 20 issues were pulled from the market because investors were insisting on yields the issuers wouldn't pay, and only 14 were executed.
By Friday the calendar of anticipated deals at some trading desks had shrunk to a meager $2.6 billion; it had been in the $10 billion to $12 billion range for much of the year.
The sudden shift in investor sentiment could be a setback for a market that big banks have entered in droves in recent years. As banks eye opportunities in securities underwriting, they have seen high-yield bonds as a natural entry point. Many banks already serve essentially the same customer base through leveraged lending.
"Bank wholesale operations have faced spread compression virtually across the board," said Brad Ball, a bank equity analyst with Credit Suisse First Boston.
Most market observers are holding their breath to see if junk bonds rebound in September or if this signals an end to an unprecedented bull run in the junk sector.
Investors, spooked by the prospect of a global economic slowdown, are insisting on higher yields in exchange for taking a risk on corporate debt. Retail investors, who make up about 20% of the market's investor base, were withdrawing money from high-yield bond mutual funds faster than they did in the weeks following the collapse of the Hong Kong stock market last fall.
Bondholders have watched their portfolios vaporize. The decline in prices this month has wiped out much of junk bondholders' profits for the year.
So far this year, the high-yield market has underperformed Treasuries, a highly unusual situation. So far this year junk bonds have returned 4.13% on average, versus 4.95% for 10-year Treasuries, according to the Merrill Lynch high yield master index.
Retail investors withdrew $297 million from junk bond funds in the first week of August, $611 million the second week, and $368.9 million last week, according to AMG Data Services.
This is a striking change in the market. By July the domestic junk bond market had surpassed last year's record-shattering $111.6 billion in new issuance, according to Securities Data Co.
The sudden downturn has hit cyclical industries particularly hard, said Martin Fridson, Merrill Lynch & Co.'s head of high-yield research.
Chemicals, metals and mining, steel, and paper have all fared poorly because of their susceptibility to cheap Asian imports, Mr. Fridson said.
Conversely, too much liquidity may have hampered the largest market sector, media and telecommunications, which makes up about 40% of junk bonds.
Fund managers who stocked up on these issues earlier in the year have stepped down their investments in this segment to broaden their portfolios, Mr. Fridson said.
Cable industry issues have so far withstood the downturn. Cable bonds were helped by active acquisition interest from strongly capitalized industry participants such as Paul Allen, the former Microsoft executive who is betting heavily on cable as a future medium of Internet access.
Over the last three weeks, spreads have widened about 16% on the yield- to-worst index, which measures the difference between the lowest yield on a callable bond compared with the yield-to-maturity on a 10-year Treasury, according to Merrill Lynch's index.
Some potentially large issuers decided to hold off on pricing their deals last week.
The clothing manufacturer Fruit of the Loom pulled $250 million of senior notes from the market. And Worldport, a Seattle-based Internet service provider, yanked $200 million of senior discounted notes.
Some of the issuers that did execute deals last week had to pay a high price to do so. Berry Plastics sold $25 million of senior subordinated notes at a coupon yielding investors 12.25%. Great Lakes Dredge and Dock Corp. sold $115 million of senior subordinated notes at a coupon yielding 11.25%.
Most junk bonds sold in the last two weeks have yielded investors around 11%, up from between 9% or 10% most of this year.