Right now, though the economy is far from extraordinary, things are fairly good. Corporate profits are strong, auto sales and home sales are solid, and unemployment numbers are low. Overall this is good news. However, there is a bit of a hidden time bomb in that good news.
Right now, you can get 6% on 5 year B rated corporate bonds. And current default rates are quite low. So why not? The answer is because that’s current default rates. Historically, default rates for a B rated bond (a very junky, junk bond) are as high as 50%. Not too many people want to earn only 6% if they have a 50/50 chance of losing a large amount of their principal.
The problem is, these are good times right now. So junk bonds seem safer, lower quality companies seem to have good earnings, and marginal real estate looks like a great deal. You always want to have a margin of safety when you invest, because the good times don’t last forever. And when the good times turn to bad times, then those investments will no longer work, and the chance of loss can be quite high.