Index March 2003 QTD YTD Description
S&P 500 0.84% -3.59% -3.59% Large-cap stocks
DJIA 1.28% -4.19% -4.19% Large-cap stocks
Nasdaq Composite 0.27% 0.39% 0.39% Large-cap tech stocks
Russell 1000 Growth 1.86% -1.07% -1.07% Large-cap growth stocks
Russell 1000 Value 0.17% -4.87% -4.87% Large-cap value stocks
Russell 2000 Growth 1.51% -3.89% -3.89% Small-cap growth stocks
Russell 2000 Value 1.07% -5.09% -5.09% Small-cap value stocks
MSCI EAFE -1.86% -8.01% -8.01% Europe, Australasia & Far East Index
Lehman Aggregate -0.08% 1.39% 1.39% U.S. Government Bonds
Lehman High Yield 2.88% 7.61% 7.61% High-yield corporate bonds
Carr CTA Index -5.80% 3.83% 3.83% Managed futures
Through March 31, 2003.

March ’03 will go down in market history as the month that could have been. The start of the long-anticipated war in Iraq and a host of analyst upgrades resulted in an impressive 15% rally from the market’s mid-month lows. But in the end, stocks only managed slight gains for March and remain in the red for the year. Notwithstanding the impressive gains of last year’s fourth quarter and a few good sessions in 2003, stocks can’t seem to get their groove back.

Thankfully, not all asset classes remain in a funk. High yield bonds started their runup in early October and have kept heading higher. So what’s the difference between the two? For clues as to why the high-yields continued to prosper in the face of a declining equity market, one must consider that junk bonds were in a serious hole as last year’s fourth quarter commenced. Thanks to the massive accounting fraud at a number of large junk issuers, 2002 turned out to be the perfect storm for defaults. According to Fitchratings.com, the number of defaulted issuers in 2002 was 163, 10 fewer than 2001′s 173. But the average size of 2002 defaults was $674 million, a 50% increase from the prior year. Further, the high-yield market was undoubtedly in a state of hangover, as the junk issued in 1997-99 represented nearly two-thirds of all defaults. The result was the widest credit spreads in years, with high-yield paper yielding nearly 1,100 basis points more than similar maturity government bonds.

Another factor keeping the high-yield market aloft is an almost fanatical view among investors that the economy is improving. Although the most recent economic data shows that manufacturing is in the doldrums and employment rates have yet to bounce, most investors feel that an end to hostilities in Iraq will result in a better economic environment. Always a forward-looking mechanism, the market seems to be taking a longer-term view than most Wall Street brokerages, which are cautioning that the odds of a double-dip recession is growing by the day.

It’s interesting to note that stock investors do not share the same level of optimism as high-yield investors. Perhaps valuation in the equity sector still remain unattractive; after all, the P/E ratio for the S&P 500 is nearly twice that what it was during the 1991′s Gulf War, and the bad news continues to come out of the airlines, autos, and tech sectors.

This leads to the most compelling explanation as to why high-yield debt is so popular: a lack of competition. Stocks may be too risky, and interest rates too low, but junk is just right. Sporting 9 percent yields and low price volatility, junk funds took in nearly $1 billion last week alone. And until stocks figure out a way to go higher, I don’t see that changing.