Although balance sheets look strong at this stage of the credit cycle, bond performance is likely to suffer ahead.

U.S. Corporate Profits: Outlook And Credit Implications. Up until now, this has been subdued by strong corporate liquidity positions, but with manufacturing activity expected to rev up (as hinted by the fairly strong ISM manufacturing numbers and orders growth) and margins of slack in the economy set to diminish, strong growth in capital expenditures will be needed. In turn, this should raise external borrowing needs.

U.S. Distressed Debt Monthly Monitor. In the U.S., the automotive, telecommunications, and retail/restaurant sectors showed the highest propensity for distress as a share of total speculative-grade rated issues.

U.S. High Yield Monthly: Cautionary Flags. However, the below 3.0% growth projected for the second-half of the year and into 2007 has historically not favored the high yield market, and a cautionary position on this asset class remains.

Rising stars still outpace fallen angels globally, though the gap is narrower than in 2005, when the number of rising stars exceeded that of fallen angels by the biggest margin since 1997.

Not surprisingly, many of the entities at risk of potential downgrades were in the consumer discretionary domain (automotive, media and entertainment, consumer products, and retail/restaurants), where pressures have been building (owing to hurricane activity, higher energy prices, and growing uncertainty about labor market conditions) and momentum is expected to decelerate, Downgrade Potential Across Credit Grades And Sectors.