Charles P. Wallace at reports that the junk-bond market has been on a tear. Rates are dropping, making it easier for even weak companies to raise capital.

One year after the worst credit crisis in living memory, U.S. markets have come back to life. That’s especially true in the nether reaches of fixed income, where rates on high-yield debt have dropped from the high teens to the high single digits since a rally started last spring.

That’s welcome news for investors. It’s also good news for smaller and medium-size companies that might not have the best credit ratings but still want to raise funds. Their ability to tap the access capital will improve as the rates on high-yield debt continue to fall. More and more companies that have been shut out of the market will find a way back.

High-yield bonds—or junk bonds, if you prefer—generated a 55 percent return in 2009, more than twice the performance of Standard & Poor’s index of 500 big stocks, which rose 23.5 percent. And while no one expects them to match last year’s rally, many experts believe that their prices will continue to rise and that their rates, which move in the opposite direction, will keep falling.

A number of factors will support the junk-bond rally for another year. “There are many of the view that earnings growth won’t sustain much growth in stocks next year. That helps explain the flows into the high-yield market, where there is a decent coupon and the prospect of at least a moderate capital gain,” says Martin Fridson, CEO of New York-based Fridson Investment Advisors. He expects junk bonds to deliver single digit gains in 2010.

That outlook is much better than at this time last year, when the credit markets were essentially frozen and fund managers were selling bonds at fire-sale prices because they were meeting a wave of redemptions. But the market reached a low point in March and began to climb back by summer. The average spread on high-yield bonds of all ratings narrowed to 6.34 percentage points from 18.86 percentage points in March, according to Merrill Lynch & Co. index data. The spread is the difference between the rate that junk-bond issuers pay and the rate that the Treasury pays to issue its debt. Bank of America Merrill Lynch said in a note to investors that the spread tightening is going to offset an expected rise Treasury yields as the Fed raises interest rates to damp down inflation fears.

Read more at: