Softpanorama

May the source be with you, but remember the KISS principle ;-)
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Junk Bonds For 401K Investors

News Coming Bond Squeeze Recommended Links Vanguard High-Yield Corporate Adm (VWEAX) Vanguard Junk Muni Fund Pimco Total Return Fund
           
Economics of Peak Energy 401K Investing Webliography Investments Scams Financial Humor Humor Etc

Most profitable investing take place in the area of medium risk. With higher risks investors often can't stummock losses and sale in the most opportune time. In low risk area you can't beat inflation.

Investors in marketable securities have little choice but to deal with Wall Street. The sad truth is, however, that many investors are not well served in their dealings with Wall Street; Wall street in first and foremost is a huge propaganda machine that acts against the interests of common investors in order to enrich the Wall Street Firms. They regularly advice to take too much risk. that means that investors, especially 401K investors they would benefit from developing a greater understanding of the way Wall Street works.  That means that they need to stady such social system as corporatism and its latest incarnation -- neoliberalism

The problem is that what is good for Wall Street typically is not so good for investors. As for high  quality bonds they sell the general rule is  "Interest rate risks can always exceed an investor's time frame in most fixed-income sectors." And Junk bonds is no exception.

But they have contain advantages, if you buy then as specialized mutual funds, not as individual issues. firs of all they have shorter duration, so this risk is proportionally less then for 30 years Treasury bonds. But with junk funds like with stocks timing is everything: they are not suitable target for cost averaging. As PIMCO Gross notes by simply researching historical annual high yield default rates (5%), multiplying that by loss of principal in bankruptcy (60%), and coming up with an expected loss of 3% over the life of future loans. So fair return for junk bonds is LIBOR + 300 or more. In other words as Gross stresses "for LIBOR+250 high yield lenders are giving away money!"

High yield issuance topped $300 billion in 2012. The majority of that was used to refinance existing debt and by the end of 2012, 80 percent of market volume ($1.13 trillion) consisted of bonds sold since 2009. Thirty-two issuers defaulted on $20.5 billion in bonds in 2012, compared with 29 issuers and $15.9 billion in 2011. Fitch believes that the default rate on high yield debt in 2013 would “at least double if the economy slides back into recession or very low growth.” Last year’s riskiest sectors were the paper and pulp industry (7.7% default rate), utilities (10.5%), consumer products (4.7%), transportation (4.4%) and banks (3.3%). From July to year-end, the volume of ‘CCC’ rated new bond issues rose 54 percent and made up 18 percent of overall junk bond issuance.

Beyond pushing out debt maturities last year, high yield borrowers in 2012 saw a decline in their interest rates as demand for their bonds rose and interest rate dropped.

Vanguard High-Yield Corporate Adm (VWEAX)

The key question here is whether the economy will go into double dip (as was widely expected in 2010) or not. Junk like some other credit markets have signs of overheating as investors take larger risks in response to the persistence of low interest rates... Recent Fed speech underscored that the Fed increasingly regards bubbles, rather than inflation, as the most likely negative consequence of its efforts to reduce unemployment by stimulating growth with money printing. ...

Simple Softpanorama Strategy (SSS)

Notes:

Close

Interest rate (annualized)

10 Year

Spread with 10 year treasuries

200 days Average

Days above/below 200 days average

Deviation from 200 days average

Signal
2/1/2013 6.12 6%. 4.00% 5.98 271 2.40% Acc
3/1/2013 6.11 6.14% 4.15% 6 291 1.80% Acc
4/1/2015 6.13 5.62 6.03 310 1.60% Hold
5/1/2013 6.21 5.61 6.07 332 2.10% Hold
5/15/2013 6.21 5.34 6.08 342 2.10% Trim
6/3/2013 6.12 6.1 355 0.40% Trim
6/14/2013 6.02 6.1 -5 -1.30% Sell
7/01/13 5.92 5.95 -20 Hold
7/15/13 5.97 -29 Hold
8/01/13 5.99 5.97 -41 Trim
8/15/13 5.94 -52 Trim
09/25/14 6.01 6.10
12/10/14

5.92

5.67

Prudent investing requires period on inactivity and that's probably one of those periods. Whether Fed manage to maintain the status quo (aka bond bubble) for another ten years like their Japan counterparts remain to be seen, but when Vanguard junk bonds fund crossed 6.31 on May 22 and 6.11 on October 10, 2007 it was a warning signal.

Bubbles can inflate and inflate, but at the end reality prevails.

The value of 200 days average is 5.98 or $.10 below the value on Feb 11 closing. This is 291 days above 200 SMA. In the past the longest period above 200 SMA was 324 days (this period ended in May 2004), so this is close to a record period for the fund. That means that talks about bubble have some ground. Generally the value above $6 for VWEAX is a sign of danger.

NOTES:

  1. Governor Stein’s paper, accompanied by correlations from Bianco Research, suggests caution in today’s high yield market (PIMCO Investment Outlook - ​Rational Temperance)
  2. You need to be able to sell a substantial part of holdings on drop. That's why I do not recommend owning Vanguard Hi YLD Corp ADM outside Vanguard account. Vanguard routinely denies sell orders for investors at retail brokers.
  3. As Bill Gross noted the current situation with credit markets resemble the song “Sixteen Tons”: Another day older and deeper in debt. So you can lose your principal by overinvesting in junk and then forced to sell at the bottom.

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Junk Bonds Whipsawed as Trading Drought Rattles Investors

Nov 21, 2014 | Bloomberg

Junk bond investors have a bad case of the jitters. Every bit of bad news is whipsawing prices, with bonds tumbling as much as 50 percent in a single day.

“We’ve seen some flash crashes in the market,” saidHenry Craik-White, a senior investment analyst at ECM Asset Management in London, which oversees $8 billion. “If you get caught on the wrong side of a name, you can get severely punished in this market.”

Investors are rattled because they’re concerned that a lack of liquidity in the bond market will make it impossible for them to sell holdings in response to negative headlines. Trading dropped about 70 percent since 2008, with a corporate bond that changed hands almost five times a day a decade ago now only being sold once a day on average, according to Royal Bank of Scotland Group Plc.

Alarms started ringing in September with the collapse of British retailer Phones 4u Ltd. after Vodafone Group Plc and EE Ltd. refused to renew contracts. The retailer shut its business and sought creditor protection on Sept. 15, sending the company’s payment-in-kind bonds down to 1.9 pence on the pound, according to data compiled by Bloomberg.

[Dec 14, 2014] Should you sell stocks Check junk bonds first

"That swing away from junk bonds often happens shortly before stock market downturns. "
Nov. 30, 2014 | money.cnn.com

One man's junk bonds might be another man's treasure.

Dramatic swings in the junk bond market often provide a valuable warning to investors. During times of turmoil, investors pile into ultra-safe U.S. government debt and rotate away from far riskier junk bonds.

That swing away from junk bonds often happens shortly before stock market downturns.

"High yield does provide useful sell signals to equity investors," Barclays analysts concluded in a recent report.

Barclays combed through the past dozen years of data. The warning signal they found is a 30% or greater increase in the spread between Treasuries and junk bonds before a dip.

History is a guide: Consider 2002. The "spread," or gap between the yields of junk bonds and Treasuries, spiked in July that summer after WorldCom defaulted on its debt and US Airways signaled it was filing for bankruptcy.

Investors who sold stocks based on the turbulence in the high-yield debt market would have escaped a 14% nosedive in the S&P 500 over the next 10 days.

"Had equity investors heeded the warning being sent from high yield, significant losses may have been avoided," Barclays wrote.

While the stock market bounced back from that 2002 episode pretty quickly, the same can't be said about when the sell signal was triggered five years later.

Junk bond spreads surged in June 2007 as two Bear Stearns hedge funds dropped a bomb on investors about massive losses in subprime mortgage assets.

Despite the alarm bells ringing in the credit markets, the S&P 500 set all-time highs as late as the fall of 2007. But then stocks began a long descent as it came to light that many more firms had similar subprime mortgage problems.

Many investors clearly wish they listened to that early warning from junk bonds.

Barclays said equity investors should "position defensively" the next time junk bonds start to go haywire. That doesn't necessarily mean dumping stocks altogether. After all, the stock market eventually bounced back from each of the sell-offs Barclays examined.

Instead, lower volatility sectors like consumer staples and utilities could provide investors with cover during a potential storm. The analysis found that after the sell signal was triggered, these sectors outperformed higher-turbulence ones like materials and energy.

[Dec 10, 2014] Oil Market Reminds Me of 1986 Price Drop Sass

(Video). Looks like his view is that the economy is entering period of high turbulence...
finance.yahoo.com

Bottom of oil prices is not seen yet. Last time in 1986 oil fall $35 to $10. Most of the damage in oil price decline behind us. But not oil speculators were washed out.

Marginal producers will go out of business. They are highly leveled and they will have problems in refinancing their debt. There will some ripple affects on financial market. Increased volatility is probably coming in 2015. Fed intend to raise rate.

High yield bond market will be affected.

[Nov 01, 2014] Richard Lehmann's 6% Solution Finding Gems Among Junk Bonds

Lehmann: Yes. We watch the market and the diversity of securities in that market. And we try to stay diversified. But one of the things about the preferred market is that it’s really quite complex. We’ve identified seven different categories of what’s called preferreds.

And the majority of the preferreds are actually bonds. They’re not stock at all. Then you have your foreign preferreds, which get dividend treatment just like a common stock in the U.S. There is a real diversity of selection, which is one of the reasons our newsletter is quite successful. Because it addresses that market and points out these differences.

Forbes: In terms of the high-yield bonds, junk bonds as we call them, you make, again, a counterintuitive case that the huge issuance which some people thought of, “Oh, my gosh. This is a bubble out there.” You say, “Well, in many cases, that’s actually a sign of strength.”

Lehmann: Yes, I do. I think that people aren’t doing their homework when they malign the high-yield market. Because they look at these spreads between investment grade, below investment grade in the past and they say, “Well, no, these spreads are so small now that the risk is not counted in.”

But I think the risk is dramatically changing by all this new issuance. Because you have to look at, really, the purpose for the bond issue, not just who’s issuing it. And if a company is issuing high-yield bonds at lower interest rates to replace, for example, existing dead issues or to replace bank loans, that’s a tremendous strength in the other balance sheet.

Because it gives them more borrowing capacity from the banks in the future if and when they need it, and when they can’t issue bonds anymore. So, actual survival chances are greatly enhanced by this volume of new issuance. The junk bonds were high risk when they were being used to make risky new acquisitions or to buy back stock. But when you’re using it to buttress your balance sheet, the way it’s being done today, I think that there’s a real positive to the market.

Forbes: You also make an interesting case, and you cite Bank of America, where the credit rating agencies end up giving a low grade, even though in reality it’s investment grade.

Lehmann: Yes. This is sort of a technical factor that distorts the market, where because somebody like Bank of America, that has four or five tiers of debt, different levels of seniority, those levels are rated by the rating agencies based on their claim in a bankruptcy situation, which would make sense except if you say, “Well, Bank of America isn’t going to go into bankruptcy. And it’s an A-rated at the top” So, you look at it and you say, “Well, that’s their chance at bankruptcy,” which is pretty close to nothing. And therefore, why wouldn’t you invest in their lower-rated paper? Because you’re not worried about their claim in bankruptcy and you can collect an extra 100 – 200 basis points of yield.

Forbes: You make the point that in some of these companies, look at what the senior debt is rated at and that, in effect, is what you should look at the junior.

Lehmann: Well, that’s what we tend to do. We think that the term junk is really detrimental to making an investment decision. They’re anything but junk.

Forbes: High-dividend stocks: You think there are some that we should look at. Everyone says go for dividends. But you make the point 2% versus 6%. But there are some like Altria that you think are worth looking at. Are there other ones? Altria do you still like?

Lehmann: There are quite a few. The tobacco companies are good. Some of the shipping companies, some of the LLPs and the master limited partnerships. These are all good categories, especially when you’re concerned about interest rates going up. They offer a lot more protection than a fixed-rate 30-year bond, for example.

Forbes: One of the things you make the point in terms of comparing junk and investment-grade bonds is that results are skewed because investment-grade bonds have a longer maturity than traditional junk bonds do.

Lehmann: Yes. That’s one of the things. We don’t tend to look at the maturity of the issues so much because in the case of high-yield bonds and in the case of our audience, which is individual investors, they’re not buying a bond necessarily to hold it to maturity. They’re buying it because it’s a good yield now. But their life span is not going to be the length of that bond issue. They’re in a different analysis position relative to what they want to buy.

Forbes: Municipal bonds, which covers a multitude of sins.

Lehmann: Of sins, yes.

Forbes: How do you look at munis today?

Lehmann: For my audience, I’ve always discouraged them from buying municipal bonds. Because I think that your investment decision should be based on rates of return that you can achieve. For years, I was mystified as to why retired individuals and such who were in a very low tax category were buying municipal bonds.

And somebody finally gave me an explanation of why they do that. And it’s basically, they say, “I want to simplify my life. I don’t want to have to worry about making a tax return and having a big payment in April. I just take all this tax-free income and I don’t have to file a tax return.”

Well, that’s the worst reason I could think of to buy municipal bonds. And as we’ve seen over time now, the quality of municipalities is deteriorating significantly. And I don’t think the market really reflects tha

Forbes: Let’s quickly hit — because a lot of people do buy these things, even if for the wrong reasons — your quick assessment of Detroit, the proposed settlement there.

Lehmann: I think Detroit is a real beginning of what may turn out to be a wave of similar-type situations. There is new ground being broken in terms of Chapter 9 bankruptcies in that case. And a lot of municipalities, I’m sure, are sitting on the sidelines watching this and saying, “Does this become a viable option to me?”

But I think more importantly is the fact that for all of these municipalities, the unions, who are usually the major claimants in this situation because of pension and health care, unfunded benefits, they need to watch this very closely. Because we’re seeing that their rights are being terminated and having to be renegotiated. And they are going to be much more flexible, I think, to avoid a Chapter 9 bankruptcy than they have been in the past. And so that’s probably one of the positives that’s going to come out of the Detroit bankruptcy.

Forbes: Another large issue out there: Puerto Rico. Is that still a wing and a prayer? There’s over $70 billion of issuance.

Lehmann: Puerto Rico, there’s no question that that is going to end up as a tragedy. There is no way that they can meet that debt level. And it’s only a question of the mechanics of, basically, how they will shorten off the debt. We see that this last bond issue and the market was very receptive to it.

But if you probably looked at who was buying that, it was the people who were looking at that bond issue as generating the funds by which they can make the interest payment on their $70 billion. Because the amount that was put out was just about what was needed for that. And I don’t know how many times you can play that game. But eventually, even with all the reforms that the new governor is promising, it’s just gotten way beyond the capabilities of the island to service that debt.

Forbes: So, would you tell individuals, “Lick your wounds and fight another day”?

Lehmann: I would say to them, “Look very closely at any municipal funds you hold and how much Puerto Rico paper is in there. Because it’s going to take a major hit.” And the same for tobacco bonds.

Forbes: I’m going to ask you about tobacco bonds, another thing, you might say, going up in smoke.


Lehmann: Yes. That’s one of those where the original basis for the issuance of many of these bonds was a study that was done in the ’70s when this agreement was reached. When the original agreement was reached here, some projections about cigarette consumptions over the next 30, 40 years were made.

And, of course, making a five-year projection, never mind a 40-year projection, is ridiculous. But the market needs something. And they all signed onto this thing. And now we’re seeing that cigarette consumption is dropping at a much greater rate than anybody had projected. And many of them are zero-coupon issues. And, consequently, those people are just trading in paper that will never pay off at maturity.

Forbes: A lot of people live in Florida. What about the so-called dirt bonds?

Lehmann: The dirt bonds is kind of a controversial thing there. Most of the dirt bonds were bought by mutual fund families and they didn’t do a hell of a good job of scrutinizing.

Forbes: Just to explain, these are housing developments.

Lehmann: Yes. These are community development districts, or housing developments, where any developer can go out and buy 1,000 acres of land, get a mortgage on it, and get all his money out of it, and then issue a $20 million bond issue or a $50 million bond issue to build infrastructure.

This was going hot and heavy in Florida until 2005, when, of course, the collapse came in the real estate market. And they continued to build out and spend all that money because they had raised it and they didn’t have any money in the deal. They’d taken their investment out through the bank loans. And, so, when they finished the infrastructure deal and it got to the point where they would have to start paying the assessments, they all said no. They let the thing default. And it has been laying in limbo. And you would’ve thought there would’ve been a wave of lawsuits as a result of that. But the mutual funds that bought these bonds were so exposed themselves for having bought them in the first place without really doing a good due diligence exam of this thing. Because it should have been obvious earlier that this was going to end badly.

Forbes: You add it up all together, Detroit, Puerto Rico, tobacco bonds, dirt bonds.

Lehmann: A lot of money.

Forbes: Munis are a minefield.

Lehmann: Tobacco bonds alone is $100 billion. That’s a huge chunk of the market. Puerto Rico is $70 billion. These are just the big ones. There are hundreds of municipalities with unfunded pension liabilities and health care who are in the same boat, just their numbers are smaller.

[Sep 26, 2014] Vanguard junk drops below 200 days simple average...

What next ?

http://www.zerohedge.com/news/2014-09-26/its-dollar-stupid To claim that this is the market at work makes no sense anymore. Today central banks, for all intents and purposes, are the market.

Our overall impression is that the Fed has given up on the US economy, in the sense that it realizes – and mind you, this may go back quite a while - that without constant and ongoing life-support, the economy is down for the count.

And eternal life-support is not an option, even Keynesian economists understand that. Add to this that the "real" economy was never a Fed priority in the first place, but a side-issue, and it becomes easier to understand why Yellen et al choose to do what they do, and when.

When the full taper is finalized next month, and without rate rises and a higher dollar, the real US economy would start shining through, and what’s more important - for the Fed, Washington and Wall Street - the big banks would start 'suffering' again.

High Yield Credit Market Flashing Red As Outflows Surge

07/25/2014 | zerohedge.com

As we have been highlighting for a few weeks, something is rotten in high-yield credit markets. This week, the mainstream media is starting to catch on as major divergences in performance (high-yield bond spreads are 30-40bps off their cycle tights from just prior to MH17 even as stocks rally to new record highs) and technicals weaken.

However, as BofA warns, flows follow returns and this week saw the biggest outflows from high-yield funds in more than a year. Investment grade bonds saw notable inflows as investors chose up-in-quality, rather than reach-for-yield, for the first time in years... equity investors, pay attention.

High yield credit markets have been overvalued for a record period of time...

On Tuesday, analysts at Ned Davis Research recommended that investors begin to sell high-yield bonds, partly because they look pricey and partly because performance has been flagging. "Investors are no longer being compensated for the additional risk in high-yield bonds," they wrote.

High yield credit markets are majorly diverging from stocks...

"Geopolitical risk is causing a pause," said Frank Ossino, senior portfolio manager at Newfleet Asset Management in Hartford, Conn., which oversees $12.9 billion. Investors tend to flee riskier assets during times of turmoil.

High yield credit markets are suffering major outflows...

Outflows from high yield funds and ETFs accelerated last week to $2.46bn following a sizable $1.85bn outflow in the prior week. Both of these outflows are the largest since the “taper tantrum”episode in the summer of last year.

"We're not seeing massive outflows yet, but at some point that's going to change," warned Phil Blancato, chief executive at Ladenburg Thalmann Asset Management, which oversees about $2 billion.

He said he is steering clear of high-yield exchange-traded funds in large part due to concerns about how they will fare in a downturn.

* * *

Between a sudden shift to a preference for "strong" balance sheet companies over "weak" balance sheet companies (the end of the dash for trash trade), and this rotation from high-yield to investment-grade, it is clear that investors are positioning defensively up-in-quality ending the constant reach-for-yield trade of the last 5 years.

Why should 'equity' investors care? The last few years' gains in stocks have been thanks massively to record amounts of buybacks (juicing EPS and also providing a non-economic bid to the market no matter what happens). This financial engineering - for even the worst of the worst credit - has been enabled by massive inflows into high-yield and leveraged loan funds, lowering funding costs and allowing CFOs to destroy/releverage their firms all in the goal of raising the share price.

Simply put - equity prices cannot rally for long without the support of high-yield credit markets - never have, never will - as they are both 'arbitrageable' bets on the same capital structure. There can be a divergence at the end of a cycle as managers get over their skis with leverage and the high yield credit market decides it has had enough risk-taking... but it only ends with equity and credit weakening together. That is the credit cycle... it cycles.

Jeff Gundlach was right.

April this year on the danger of junk bonds

2014-04-30 | Bloomberg

The U.S. drive for energy independence is backed by a surge in junk-rated borrowing that’s been as vital as the technological breakthroughs that enabled the drilling spree. While the high-yield debt market has doubled in size since the end of 2004, the amount issued by exploration and production companies has grown nine-fold, according to Barclays Plc. That’s what keeps the shale revolution going even as companies spend money faster than they make it.

“There’s a lot of Kool-Aid that’s being drunk now by investors,” Tim Gramatovich, who helps manage more than $800 million as chief investment officer of Santa Barbara, California-based Peritus Asset Management LLC. “People lose their discipline. They stop doing the math. They stop doing the accounting. They’re just dreaming the dream, and that’s what’s happening with the shale boom.”

... ... ...

Spending Treadmill

“Who can, or will want to, fund the drilling of millions of acres and hundreds of thousands of wells at an ongoing loss?” Ivan Sandrea, a research associate at the Oxford Institute for Energy Studies in England, wrote in a report last month. “The benevolence of the U.S. capital markets cannot last forever.”

The spending never stops, said Virendra Chauhan, an oil analyst with Energy Aspects in London. Since output from shale wells drops sharply in the first year, producers have to keep drilling more and more wells to maintain production. That means selling off assets and borrowing more money.

“The whole boom in shale is really a treadmill of capital spending and debt,” Chauhan said.

Access to the high-yield bond market has enabled shale drillers to spend more money than they bring in. Junk-rated exploration and production companies spent $2.11 for every $1 earned last year, according to a Barclays analysis of 37 firms.

...

“It’s a perfect set-up for investors to lose a lot of money,” Gramatovich said. “The model is unsustainable.”

[Apr 23, 2014] Junk Bonds: Not Worth the Risk ?

At $6.12 per share Vanguard High Yield is too pricy
Many top bond investors, including Doubleline's Jeffrey Gundlach, believe high-yield bonds are overvalued after a long run.

Vanguard High-Yield Corporate Fund Admiral Shares

YTD 1 Yr 3 Yr 5 Yr 10 Yr
+3.26% +5.63% +8.41% +14.60% +7.06%

Wolf Richter: Bubble Trouble: Record Junk Bond Issuance, A Barrage Of IPOs, “Out Of Whack” Valuations, And Grim Earnings Growth

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.

When Blackstone’s global head of private equity, Joseph Baratta, said Thursday night that “we” were “in the middle of an epic credit bubble,” the likes of which he hadn’t seen in his career, he knew whereof he spoke.

Junk bond issuance hit an all-time record of $47.6 billion in September, edging out the prior record, set in September last year, of $46.8 billion, according to S&P Capital IQ/LCD. Year to date, issuance amounted to $255 billion, blowing away last year’s volume for this period of $243 billion. The year 2012, already in a bubble, set an all-time record with $346 billion. This year, if the Fed keeps the money flowing and forgets about that taper business, junk bond issuance will beat that record handily.

Junk-bond funds got clobbered in July and August as retail investors briefly opened their eyes and realized what they had on their hands and fled, and they went looking for yield elsewhere, but there was still no yield in reasonable places, and so they held their noses and picked up these reeking junk-bond funds again. Cash inflow doubled over the last week to $3.1 billion, the most in ten weeks.

These retail investors were fired up by the Fed’s refusal to taper even a little bit, giving rise to the hope that it might actually never taper, that this is truly QE Infinity, Wall Street’s wet dream come true – on the theory that the Fed is mortally afraid that any taper would blow over the sky-high financial-markets house of cards it has constructed over the last five years. And the retail cash returned to these junk-bond funds and just about refilled the hole that had been dug during the summer.

“The cost of a high-yield bond on an absolute coupon basis is as low as it’s ever been,” explained Baratta, king of Blackstone’s $53 billion in private equity assets. Even the riskiest companies are selling the riskiest bonds at low yields. The September frenzy hit the upper end too and set a new record: companies sold $145.7 billion in investment-grade bonds in the US. And Baratta complained that valuations “relative to the growth prospects are out of whack right now.”

These “growth prospects” look grim, with corporate revenues barely keeping up with inflation, and with earnings growth, despite all-out financial engineering, getting decimated. On October 1 last year, earnings estimates for the third quarter 2013 still saw a growth of 15.9%. As of Friday, estimated earnings growth had plunged to 4.6%, dropping 20 basis points per week in August and 10 basis points per week in September. And they may still be too optimistic.

Meanwhile, earnings growth estimates for the fourth quarter have barely budged since August and remain at the deliriously lofty level of 11.1%, pulled up largely by financials, whose earnings growth is still pegged at a breath-taking 25.7%, based on the assumption that the Fed will continue to feed them.

But financials are having some, let’s say, issues. The five biggest banks alone face a $1 billion cut in earnings from just the past month, based on a big decline in fixed-income trading revenues – with our special friend, JPMorgan, eating more than half of it. There had been “hopes of a final trading flurry in the last few weeks of the quarter,” the FT observed, but those hopes have now been squashed.

Then there is the death of the mortgage refi bubble that has been hammering banks, with number one mortgage lender Wells Fargo suffering the most. Four banks have so far announced 7,000 layoffs in their mortgage divisions. JPMorgan confessed that it would lose money in its mortgage business in the second half. On top of that, JPMorgan is contemplating $11 billion in legal settlements for its various mortgage scams. And earnings at financials are still expected to grow 25.7% in the fourth quarter?

“Out of whack” is what Baratta called this phenomenon of sky-high valuations in relationship to grim growth prospects.

Earnings estimates have been slow in coming down. And the stock market, supposedly forward looking and focused on corporate revenues and earnings, has been completely blind to them. It follows the mantra that fundamentals no longer matter. All that matters is the Fed. A shift that has become the Fed’s most glorious accomplishment. And the Fed continues to feed Wall Street with $85 billion a month.

Yet in this glorious environment where there is no gravity for stocks and even junk bonds, the smart money is selling hand over fist, unloading whatever they can, however they can. Record junk bond issuance is just one aspect.

from Mexico

October 1, 2013 at 5:31 am

It looks like one of the consequences of QE has been to drive investors into increasingly high-risk investments in quest of yield. I don’t see how this can end well.

Our current era seems to resemble the 1890 to 1914 era in many ways, poised as it was on the precipice of three decades of world-wide war and depression. When the rentier’s quest for yield blows up in their faces, the quest for scapegoats will begin.

As Jacques Barzun asks in From Dawn to Decadence,

how can it be that in retrospect the period was seen as an ideal time deserving to be called la belle epoque? … Here it is enough to say that the intellectual and artistic elites, and to a certain extent high society, lived in their world of creation, criticism, and delight in the new. They were aware of the crises, no doubt, but after one or two had gone by gave little thought to what they might still cause. At any rate, those engaged in high art and science took little notice.

[....]

The haughty ignorance of social and political facts enables us to understand why the cultivated classes reacted as they did when war came: several hundred intellectuals in Germany signed a manifesto denouncing “the other side” as if betrayed by a friend and brother. It was immediately answered, with a like rhethoric, by several hundred of the French. The enemy’s purpose must be wicked since we are innocent.

[....]

Overnight, en masses like so many sheep, they turned into rabid superpatriots….

Looking over the roster of great names in literature, painting, music, philosophy, science, and social science, one cannot think of more than half a dozen or so who did not spout all the catchphrases of absue and vainglory….

Freud wrote of “giving all his libido” to Austria-Hungary. The historians and social scientists — Lamprecht, Meinecke, Max Weber, Lavisse, Aulard, Durkheim, Tawney — all found in the materials of their field good arguments in praise of war or reasons to excoriate the enemy. Arnold Toynbee wrote volumes of atrocity propaganda…

And everywhere the clergy were the most rabid glorifiers of the struggle and inciters to hatred. The Brotherhood of Man and the Thou Shalt Not Kill were no longer preachable…. They enlisted God: “He is certainly on our side, because our goals are sinless and our hearts are pure.”

The most moderate said: “Kill but do not hate.” One English preacher spoke of “the wrath of the Lamb” and another speculated that although Jesus would not have become a combatant, he would have enlisted in the Medical Corps.

susan the other

Right. And it is still just as terrifying to know that history dictates, proves, that we are all totally nuts.

Moneta
  • The market is forward looking in pricing positive or negative delusions.
  • I regularly look at page 21 of this report:
  • http://research.stlouisfed.org/publications/net/
  • The market has a hard time noticing drops in earnings. It usually takes a few quarters of dropping corporate profits to GDP before the market really reacts.
  • Right now, the ratio is still at an all-time high so we probably still have a few more quarters of optimistic delusions… but the debt market is usually faster on the trigger.
  • MikeNY

    Functionally, the Fed believes that the only cure for a burst bubble is a bigger bubble — so this comes as no suprise. They appear to be wilfully blind that, in an era of plutocratic concentration of wealth, the old supply-side nostrums don’t work.

    The economic model is broken, and until we have a large redistribution of wealth in America, it will stay broken. The bi-partisan focus on ‘growth’ is a red herring, a distraction, so that we don’t have a conversation about the real problem.

    Code Name D

    But they don’t believe in bubbles. Any more than they believe in evolution, global warming, or that the poor can only afford to take weekend trips to the Bahamas.

    TimR

    …”before the Fed turns off its crazy money spigot”

    “if the Fed keeps the money flowing and forgets about that taper business”

    “And the Fed continues to feed Wall Street with $85 billion a month.”

    I’m still confused about QE. In a recent podcast with Stephanie Kelton and Warren Mosler (at neweconomicperspectives.org ), Mosler says, IIRC “..but QE doesn’t flood the market with money.” He describes QE as (correct me if I’m wrong) just shifting assets from the banks’ savings account at the Fed, to their checking account at the Fed (although these accounts are called Treasuries and Reserves, they amount to savings/checking accounts.)

    In the Randy Wray podcast (also at newecon), he says if QE ended, there would be a brief turmoil in the markets, and then investors would realize it didn’t really make any difference.

    Mosler also says that far from increasing the money supply, QE actually *removes* money from the economy, by turning interest-bearing assets into non-interest-bearing assets. And just because they’re more liquid, doesn’t mean people will run out and spend them into the economy. (One question I have on this aspect of it: what mechanism lets the Fed convert other parties’ bonds to reserves, is it voluntary or involuntary for those bond-holders?)

    I’m still looking for a really lucid source that describes in detail what’s going on with QE. Mosler is great but I can’t find an article by him drilling down into some of the details that are still unclear to me.

    But posts like this throw me off, given Mosler’s seeming authority and expertise. Is Wolf Richter just speaking in some shorthand, or does he not know what he’s talking about wrt QE?

    Moneta

    For example:

    The Fed decides to buys MBS… Pimco might be the seller… then Pimco ends up with cash which permits it to buy something else… government bonds, newer MBS, high yield, etc? So part of this money ends up in the economy and another part moves around across pension plans.

    With low velocity, I would say that a lot of this money is just flowing up into the large DB plans.

    Dan Kervick

    Right, but because that MBS that once belonged to Pimco now belongs to the Fed, that cash flows attached to the MBS that would have gone to Pimco go to the Fed instead. So over time, about as much money is drained out of the private sector to the Fed as was injected into the private sector by the Fed’s purchase.

    Moneta

    Not really because the new security that replaces the MBS has coupons also. Furthermore, if those MBS were backed by delinquent mortgages, no money would have been flowing anyway. Also, because the pension plans got propped up, pension benefit cheques are still being sent to retirees.

    However, one thing is for sure, money is getting parked…
    instead of having dollars move hand to hand, government must generate more dollars of debt to generate GDP.

    susan the other

    But the bottom line is that capitalism, not just our brand of gangster capitalism, is dead in the water. Capitalism relies on skimming from somewhere – excessive growth; trashing the environment; screwing labor, etc. Nothing is going to revive it now. We are “in crisis” because the old economy is useless and we will be here for a long time, years, maybe decades. So what’s a Fed Head to do? Just keep the money circulating as much as possible. Life support. It is, however, a life support system that left out all but the very rich. So it will not save them either. Poetic justice. And Congress? Forget it.

    Sufferin'Succotash

    The situation resembles that editorial cartoon back in the late 1920s showing an endless belt with money flowing from Germany to France as reparations, from France to the US as repayment of war debts, then from the US back to Germany as loans.

    Something in it for everybody (snicker)!

    markf

    “I’m still confused about QE.”

    You’re not alone.

    I’ve read articles by people explaining in incomprehensible (to me) detail, either why it’s great, or why it’s terrible.

    and none of them seem to be able to write an explanation without using words and acronyms that I suspect many people don’t understand.

    They’re talking to each other I suppose.

    my simple question is, who is getting the credits, the money, and what are they using it for?

    Where’s it ending up? Is it going into the stock market?

    is there a simple, layman’s explanation for this? without any insider jargon?

    craazyboy

    “The Fed Winged It”

    Moneta

    QE is good if it props up confidence and stops the world from imploding (which it did) but is bad if it generates a drop in confidence by squeezing out industry (which it is increasingly doing).

    Go look at the balance sheets of the large consumer discretionary stocks over the last 1-2 years, compare it to the stock prices and tell me that their activity inspires confidence in future economic growth.

    participant-observer-observed

    DIY QE education via “Quantitative Easing Explained” with 5.6 million views since 11/2010!

    http://www.youtube.com/watch?v=PTUY16CkS-k

    And “Quantitative Easity Revisited”

    http://www.youtube.com/watch?v=oGIvw7T0GPI

    I wonder if NC readers find anything false in these.

    markf

    thanks.

    Code Name D

    “I’m still confused about QE. In a recent podcast with Stephanie Kelton and Warren Mosler (at neweconomicperspectives.org), Mosler says, IIRC

    “..but QE doesn’t flood the market with money.” He describes QE as (correct me if I’m wrong) just shifting assets from the banks’ savings account at the Fed, to their checking account at the Fed (although these accounts are called Treasuries and Reserves, they amount to savings/checking accounts.)”

    Ha ha! That’s a good one. The guy probably even believes it too.

    Creating money is actually quite easy. *Poof* I just created a million Dubies. Want to see me do it again? *Poof*, another million Dubies. But the trick is getting some one to take my Dubies in trade for goods and services. In fact, my Dubies can’t even be called a currency until they are accepted as a medium of exchange. I haven’t actually made any Dubies, until I spend them into existence.

    But there is another quirk here. If I was to accept a Dubie in exchange for something, as I was the originator of the Dubie, then the Dubie poofs into the same nothingness from whence it came. And this would only make sense, if I can create Dubis at will, than by definition a Dubie must have zero value to me. So every Dubie I take back, regardless of what I do with it later, effectively removes it from the economy.

    Thus the amount of currency in circulation becomes a balance equation; if I spend more Dubies than I accept in trade, then the supply of Dubies is growing in the broader economy.

    For the good old US of A, the one who poof’s US dollars into existence isn’t the US Treasury as you might think, but the Federal Reserve. This is why the government has this national debt because they have to schlep it like the rest of us.

    So when the Fed “buys” any thing; from toilet paper for the office to trillions in mortgage backed securities, it is buying it with dollars that were poofed into existence. Regardless of the mumbo-jumbo they try to peddle about over-all balance sheets.

    That gives you the fed’s side of the story. But with Quantitative Easing, there is the other side of the store that is told by the too-big-too-fail-banks.

    The Fed’s theory about “the liquidity crises” is that the banks had a ton of assets that had temporally been devalued in price, thanks to the “great recession”. (Snic- oh you just got to love that spin.) But once the recovery takes hold, and the economy is always in recovery, than all of those mortgage backed securities will snap back in value, and even start turning a profit again.

    So to tide things over, the Federal Reserve basically buys bank-generated assets, such as mortgage backed securities, and holds them for later. When things recover, the Fed will start selling the assets back to the bank. So they aren’t running those printing presses to cause the next Weimar Hyperinflation… oh no this is only temporary. See how clever they are?

    Of course, now the 2B2F banks have an incentive to create worthless paper assets, knowing full well the Fed will buy them – no questions asked. And the FED doesn’t risk any thing because it’s the one that created to dollars in the first place. Indeed, they seem to have a preference for the junk as they are the only ones who will buy it. The Federal Reserve has basically become the consumer of last resort. The banks then have all that brand new free cash to play with which they can used to go gambling in the great global casino called the stock market. Or better yet, they can use those new dollars to create even MORE worthless assets with which to sell to the fed.

    That is basically what is happening. The rest of the mumbo-jumbo you hear is just gibberish to try and obfuscate and conceal that this is actually happening, or more likely in an effort to puff themselves up and make themselves look… well…competent. All though I suspect they set there self delusionary image a lot higher than that. It’s good to have goals I suppose.

    So where is the hyper-inflation you may be asking? Well, it turns out that you don’t create hyper-inflation by simply flooding the market with a currency you just printed. Why this is… is complicated. It’s also some what off topic.

    But there is another explanation. As I said before, a currency has to be spent into existence. But the fed isn’t actually spending it, but rather simply making transfers in exchange for fiscal assets that are as equally made up. The 2b2fb take their new cash and “invest” them into other paper assets, which are also fabricated from out of thin air, and which value expands only because other 2b2fb are taking their new Fed cash and trying to buy the same paper assets.

    Because the banks are basically creating assets to be sold to the fed, the 2b2fb have basically become a defacto extension of the fed. And like the fed, every dollar the 2b2fb take in – effectively disappears from the economy, regardless of what their balance sheet shows or how they chose to invest it in the stock market or other speculative bubbles.

    Despite all the talk of Taper, the reality is that the fed CAN’T stop quantitative easing or the whole thing will simply implodes. But nor is all of the new fed money contributing to the economy because its all going to making more money through financing.

    “Mosler also says that far from increasing the money supply, QE actually *removes* money from the economy, by turning interest-bearing assets into non-interest-bearing assets. And just because they’re more liquid, doesn’t mean people will run out and spend them into the economy. (One question I have on this aspect of it: what mechanism lets the Fed convert other parties’ bonds to reserves, is it voluntary or involuntary for those bond-holders?)”

    Well Mosler is not entirely wrong, but not for the reason he states. (FYI: Interest baring assets do not add currency to the economy.) Remember that balance sheet equation? If the fed spends more money than it takes in, then it is expanding the money supply. But if the 2b2fb have become extensions of the Federal Reserve because they in effect create money out of thin air, then they also have the consequence of destroying the money that they take onto their balance sheets. It then becomes a question of weather the 2b2fbs are spending more money then they are collecting.

    As for the last part of your question… I have…. no clue.

    ian

    “Despite all the talk of Taper, the reality is that the fed CAN’T stop quantitative easing or the whole thing will simply implodes.”

    Of course, that’s the best reason for stopping it. Do it now, or do it later, with later being much worse.

    Moneta

    The debt situation is worse now than it was in 2008. So if the Fed did not let stuff default then, why would it start now?

    IMO, the Fed taper will depend on the ROW crumbling first.

    Walter Map

    And the stock market, supposedly forward looking and focused on corporate revenues and earnings, has been completely blind to them. It follows the mantra that fundamentals no longer matter. All that matters is the Fed. A shift that has become the Fed’s most glorious accomplishment. And the Fed continues to feed Wall Street with $85 billion a month.

    Since 2008, Obama’s policies and the Fed’s policies have succeeded in reinflating the financial industry at the cost of an enormous amount of debt. The status quo has been preserved, but the real economy has been cannibalized and not restored. There have been no reforms, ensuring a repeat of the 2008 meltdown at an even greater scale. Wall St. is more out-of-control than ever.

    Debt will allow you to ignore the fundamentals and put off the reckoning, but only for so long. That time is running out, and the rats are cashing in and jumping ship:

    But now the smart money is scrambling to issue paper … before the Fed turns off its crazy money spigot

    This will all end in tears.

    skippy

    Something about rumor control a la Jim Rickards and any next event requiring an IMF SDR thingy… ouch.

    Moneta

    Many seem to think that QE was for the elite only. But it has also been for the benefit of the top 10-15%. Those with a pension.

    90% of DBs are something like 30% underfunded. Without QE, I can imagine how many write-offs they would have had to do. How even more underfunded plans would have been.

    Then, some propose having the government print, print, print without issuing debt… makes one wonder what these underfunded plans would buy! More corporate bonds based on easy printing? If we chose to go this route, chances are all plans would have to go pay-as-you-go. That would mean HUGE upheaval in the markets. The people would hate the elite even more… revolutions often start when the top 10-15% get angry but these QEs have been neutering them.

    MikeNY

    The benefit of QE to pension funds depends on the asset mix. Equities have recovered, but fixed income yields have evaporated. So the Fed is forcing pension funds into a riskier asset mix (equities, alternative investments) as opposed to traditional I-grade corporates and treasuries.

    I suggest QE is merely kicking the can wrt to pension funds, because what QE has done is to accelerate a decade or more of equity gains into the last couple of years. The hope was that the economy would attain “escape velocity” and justify the multiples and historically high profit margins.

    As Ben Inker at GMO has written, this hope is justified only if the majority of American willingly embrace serfdom.

    Moneta

    Yup. But they still got another good 4-5 years of bond gains and bailouts and QE propped up equities. It has probably given most DB pensioner n extra 5-10 years of benefits.

    With no bailouts and QE, there would have been write-offs in bonds and equities would not have moved up as much. DB plans would have had to cut.

    The reality is the leaders do not want to be the ones telling the top 10-15% that they are broke. They will do whatever it takes to just let it happen through what appears like market forces. That’s what is great with being able to blame a central bank, it’s impersonal.

    Also, they probably intuitively know that the real trouble will come when those DBs go bust.

    minimus

    Credit bubbles are marked by the use of a ton of leverage in the corporate sector, usually in the form of a wave of mega-LBOs. In the late 1990s and in 2005-2006, there was a new giant LBO announcement splashed across the front page of the Wall Street Journal practically every other day. That was a tell-tale sign of a credit bubble, a sign that was followed by a collapse of the credit markets in 2001-2002 and in 2008-2009. The absence of mega-LBOs in the current market suggests we are not in a credit bubble.

    But I can see why this guy Baratta is complaining. In a “normal” environment, he would take a company private at a low multiple to EBITDA, use cost-cutting and fast economic growth to grow EBITDA, and then sell the company back to the public at a higher multiple. Boo hoo, multiples aren’t low enough to ensure he will double his money at every one else’s expense. Too bad.

    allcoppedout

    I like the idea of there being a simple answer to QE or the world financial system. Let’s face it, economics must be simple or the buffoons we elect wouldn’t be able to understand it.

    In principle QE sounds like it matters where you stack your money, almost as if moving it around the vault has some kind of ‘astrological effect’ on the real economy. Anyone who believes this should send their life savings to ACOPONZI (Cayman Offshore Secure Holdings) Inc before Jupiter next blinks. Send with complete power of attorney – we don’t want regulatory red tape getting in the way of profits …

    In ACOPONZI I’d no doubt start by lying to you – triple your money in months and such. QE started with a lie – it was to boost loans to the real economy and so on. I’m ex-cop and saw hundreds of scams as ‘simple’ as QE. A good one to look at now is the rip-off of US municipals http://www.rollingstone.com/politics/news/the-scam-wall-street-learned-from-the-mafia-20120620

    I generally found juries immune to fraudsters and their lawyers and this holds in the US municipals case. I think we need to ‘go cop’ to see that QE is really just a simple scam. As in the case Tabbi reports, we the public are the losers and a small few have been facilitated in looting. We need to boil it down to Cui Bono.

    The banking system clearly could not be supported by different astrological positioning of money. In the Carrolo trial wiretaps clearly demonstrate the simple scam.

    I guess QE somehow facilitates drawing fresh money in the Ponzi and the hiding of losses in an 888 account. The defense is that this is for the good of us all because otherwise the sky will fall. What we need to understand this is not the espoused theory of QE but the money trail and transaction transcripts of its theory-in-practice.

    Our municipalities had plenty of well-qualified and well-paid lawyers and accountants, but were ripped off by a simple scam. The Fed and BoE have lots of well-qualified people too. QE will turn out to be a simple scam. We don’t need complex explanations, but do need evidence of the transactions it has allowed. Anyone really want to bet on who is holding the debt parcel?

    [Oct 01, 2013] Remember When Republicans Were Worried about Uncertainty

    Economist's View

    Matt Young

    http://www.reuters.com/article/2013/10/01/us-debtceiling-dimon-idUSBRE99002020131001
    (Reuters) - JP Morgan chief executive Jamie Dimon is headed for a scheduled meeting, along with other bank executives, with President Barack Obama on Wednesday, the Wall Street Journal reported.

    While talking to WSJ, an industry participant said concern over the debt ceiling battle would be raised during the meeting.
    ------------
    On the first day of shut down my true love gave to me
    One JP Morgan CEO

    Matt Young

    Wolf Richter: Bubble Trouble: Record Junk Bond Issuance, A Barrage Of IPOs, “Out Of Whack” Valuations, And Grim Earnings Growth

    By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.

    When Blackstone’s global head of private equity, Joseph Baratta, said Thursday night that “we” were “in the middle of an epic credit bubble,” the likes of which he hadn’t seen in his career, he knew whereof he spoke.

    Junk bond issuance hit an all-time record of $47.6 billion in September, edging out the prior record, set in September last year, of $46.8 billion, according to S&P Capital IQ/LCD. Year to date, issuance amounted to $255 billion, blowing away last year’s volume for this period of $243 billion. The year 2012, already in a bubble, set an all-time record with $346 billion. This year, if the Fed keeps the money flowing and forgets about that taper business, junk bond issuance will beat that record handily.

    Junk-bond funds got clobbered in July and August as retail investors briefly opened their eyes and realized what they had on their hands and fled, and they went looking for yield elsewhere, but there was still no yield in reasonable places, and so they held their noses and picked up these reeking junk-bond funds again. Cash inflow doubled over the last week to $3.1 billion, the most in ten weeks.

    Read more at http://www.nakedcapitalism.com/2013/10/wolf-richter-bubble-trouble-record-junk-bond-issuance-a-barrage-of-ipos-out-of-whack-valuations-and-grim-earnings-growth.html#ark1SZUXS2TjE6SW.99

    --------------
    I wonder if Dimon and Obama will notice that ginormous bubble in the market?

    Matt Young

    Bloomberg:

    U.S. stock-index futures advanced, signaling the Standard & Poor’s 500 Index will rebound from a three-week low, as investors weighed the impact of the first partial government shutdown in 17 years.

    Merck & Co. jumped 2.9 percent after the company announced an overhaul that will eliminate 8,500 workers. Under Armour Inc. increased 0.9 percent as JPMorgan Chase & Co. upgraded the maker of workout clothing. Symantec Corp. lost 2 percent after saying its chief financial officer left.
    --------------
    Shutdown? What shutdown?

    Matt Young

    http://www.zerohedge.com/news/2013-10-01/next-subprime-crisis-expands-student-loan-defaults-hit-146-billion-highest-default-r

    Yesterday, ED.gov provided its annual update - this time to the 2010 three year and 2011 two year cohorts - and to nobody's major surprise, learned that things just got even worse. To wit: "The national two-year cohort default rate rose from 9.1 percent for FY 2010 to 10 percent for FY 2011. The three-year cohort default rate rose from 13.4 percent for FY 2009 to 14.7 percent for FY 2010." Putting this in context, according to Bloomberg defaults have risen to the highest level since 1995.

    -----------
    This is what has been driving JP Morgan out of the business for the past few months.

    Fred C. Dobbs

    (True Believers are always Right.)

    Conservatives With a Cause: ‘We’re Right’ http://nyti.ms/15HBDIb
    NYT - September 30, 2013 - ASHLEY PARKER

    WASHINGTON — ... Senator Harry Reid, the Nevada Democrat and majority leader, had his own colorful, if somewhat skewed, metaphor about why much of the government was about to grind to halt in a take-no-political-prisoners fight over what is essentially a simple six-week funding bill, attributing it to the emergence of a “banana Republican mind-set.”

    Mr. Reid’s language was evocative, and the implication was serious. With Democrats controlling the White House and Senate and with millions of dollars spent getting the health care law to the starting line, what gives House Republicans the idea that they can triumph in their push to repeal, or at least delay, the Affordable Care Act when so many veteran voices in their party see it as an unwinnable fight?

    “Because we’re right, simply because we’re right,” said Representative Steve King, Republican of Iowa, one of the most conservative of House lawmakers. “We can recover from a political squabble, but we can never recover from Obamacare.”

    Representative Raúl Labrador, Republican of Idaho and one of the original proponents of the so-called Defund Obamacare movement, was similarly sanguine. “We can always win,” he said Monday afternoon, as he jogged up the stairs to a closed-door conference meeting, where House Republicans gathered to plot their next move.

    Representative Pete Sessions, Republican of Texas and chairman of the House Rules Committee, hinted that Republicans were unlikely to give up without at least another round since they see their campaign against the health care law as something of a higher quest. And many, if not most, people they talk to — colleagues, friendly constituents, activists, members of advocacy groups — reinforce that opinion, bolstering their belief that they are on the right side not just ideologically, but morally as well.

    “This isn’t the end of the road, guys,” Mr. Sessions said with a grin. “This is halftime.” ...

    High yield bonds, the pain continues and will only get worse

    Market Realist

    Fund flows rebound

    Fund flows rebounded significantly last week, reaching $1.4 billion versus $0.4 billion the week before. While this value is still below the huge $1.7 billion spike the week prior, it certainly shows that investors are still willing—at least for one last week—to speculate on bonds.

    Nonetheless, as we’ve discussed, the statements by three Fed presidents are likely to dampen investor excitement.

    August slowdown?

    August is usually a slow month, though this year, investors have pushed well into August, squeezing the last yield of the bond market (BND). The strong volumes from last week, though, may be the result of several issuers piling in before most of the dealmakers go on vacation.

    If issuance volumes drop by the end of this week, the secondary market is likely to slow down as well. By the time the August vacation is over, the September tapering will be upon us. So right now may be a good time to hedge or get out.

    Read on to see how the high yield bond market has behaved recently.

    Continue to Part 4: Downside potential in September for high-yield bonds

    But after August comes September, along with more tapering concerns, budget discussions, and debt ceiling hype. High yield bonds (HYG) are unlikely to move significantly higher in August, and September will only bring a wild ride of volatility with significant downside potential.

    The high yield market (JNK) volume was extremely bullish last week, to say the least

    The fund flows for last week once again plummeted as investors remove cash from bonds ahead of the FOMC meeting.

    Fund flows are key in determining the sentiment of investors towards a given asset class. Weekly fund flows measure how much cash investors put into and remove from mutual funds focused on investing in high yield bonds.

    The $3.3 billion outflow last week follows an all-time high outflow of $4.6 billion the prior week. The year to date outflows are now $6.3 billion, after been positive just two weeks before. This strong reversal towards the negative side emphasizes how investors fled the asset class in anticipation of rising interest rates.

    Investors averse to high duration

    The fixed coupon of bonds makes them sensitive to changes in interest rates, causing the price of the bonds to fall as interest rates rise. Since the rise in interest rates is imminent, investors have been trying to off-load their exposure to bonds.

    The upcoming Federal Open Market Committee (FOMC) will have Federal Reserve Chair Ben Bernanke issue a statement of their outlook on the economy and interest rates. If his message hints at an earlier than expected tapering of the expansionary monetary policy, then rates will go up. The Federal Reserve has been buying over $80 billion in long term Treasury and mortgage bonds, artificially increasing the demand and causing interest rates to fall. When these actions are removed, the rates will slingshot back up.

    GETTING PERSONAL: Seeking a Less Rocky Road in Corporate Bonds

    Jul 29, 2013 | ETRADE

    (This article was originally published Friday.)

    --Managers find investment-grade bonds attractive

    --Some high-quality bond funds holding up better

    --Despite risks, investors jump back into junk

     
       By Murray Coleman 
     

    Yield-starved fund investors ready to move back into more risky corners of corporate bond markets might first want to pause and catch their breath, which is what many investment advisers are doing.

    Instead of loading up on so-called high yield, or junk, they're taking advantage of greater opportunities in higher-rated issues.

    Since a sharp sell-off in bonds from mid-May through late June, investment-grade corporates are looking more attractive by some valuation measures. With prices moving inversely to yields, such high-quality fare are also sporting more appealing income streams.

    "We're finding investment-grade corporates to be a good place to hide out as bond markets search for some sort of equilibrium," says Lucas Turton, chief investment officer at Windham Capital Management in Boston with $1.2 billion in assets.

    In mid-June, portfolio managers at the advisory firm started to slash holdings in junk exchange-traded funds. At the same time, they began adding to investment-grade corporate positions. A current favorite is the Vanguard Short-Term Corporate Bond ETF (VCSH).

    With tapering of the Federal Reserve's massive bond-buying program and historically low interest rates still a concern, Mr. Turton says that "it just doesn't seem like a good time now to court more risk by moving too deeply into high-yield bonds."

    While junk funds could be setting up for a stronger second-half, advisers point to several overhanging clouds.

    "Although we expect better performance from high-yield bonds compared to investment-grade over the next several quarters, market volatility is also likely to be higher," says Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC.

    The speculative U.S. bond market's default rate is on-pace to increase to 3.2% by November, Moody's Investors Service predicted earlier this week. That would be up from the second quarter's 2.9%, but still well below the 4.5% average since 1993.

    "They're a more boring choice, but investment-grade corporates are standing on a little less scorched earth than high-yield bonds," says Daniele Donahoe, chief investment officer at Rinehart Wealth Management in Charlotte, N.C., with $300 million in assets.

    Investors remain tentative about lower yielding parts of the corporate-bonds landscape, according to data from market researcher IndexUniverse. Since late June, net inflow into U.S. investment-grade corporate bond ETFs was at $203 million by mid-week, still far from replenishing a previous 30-day period of heavy losses.

    At the same time, investors are returning to junk-bond funds in force. Since policy makers began reassuring markets about their economic stimulus plans, more than $2.9 billion has flowed into junk bond ETFs.

    Investors are largely neglecting higher-quality bond funds, some of which are actually holding up better than their junk rivals, Ms. Donahoe says. One of her favorite picks is the iShares Intermediate Credit Bond ETF (CIU). While its returns dropped 3.57% from May 22 through June 25, the iShares 7-10 Year Treasury Bond ETF (IEF) lost 4.21%. Also, the iShares iBoxx High Yield Corporate Bond ETF (HYG) slumped by 4.59%.

    "This sell-off was duration-based and investors need to be aware that big differences exist even within bond funds that are classified as intermediate-term," Ms. Donahoe says.

    The biggest player in the field by assets, the $19.3 billion iShares iBoxx Investment Grade Corporate Bond ETF (LQD), has a weighted average maturity more than twice that of the iShares Credit Bond fund. It fell 6.07% in the pullback.

    As long as defaults remain below long-term averages and a relatively low-rate environment persists, investors trying to live on fixed incomes should use all of the tools at their disposal, says Wes Moss, chief investment strategist at $1.1 billion Capital Investment Advisors in Atlanta.

    His idea: Stick with investment-grade corporates at the longer-end of the intermediate curve like the iShares Investment Grade Corporate ETF. It has a distribution yield of 3.90%, more than the shorter-termed iShares Credit Bond ETF's 2.69%.

    While higher credit quality corporates typically produce lower income streams, Mr. Moss says that many high-yield bond ETFs come with relatively low durations, which are measures of interest rate sensitivity.

    The iShares High Yield ETF, for example, has a duration of 4.1 years with a yield of 6.45%.

    "We're using high-yield bonds in combination with investment-grade securities to lower portfolio durations," Mr. Moss says. "It's really the best of both worlds. We're generating higher income and still keeping interest rate risks at bay."

    (Murray Coleman is a wealth management columnist who writes about investing in exchange-traded funds and new trends in mutual funds. He can be reached at: murray.coleman@wsj.com)

    Subscribe to WSJ: http://online.wsj.com?mod=djnwires

    [Jun 25, 2013] For Bonds, It's A Lehman Repeat

    "There is no rotation that drives high-yield credit spreads wider without punishing equities"
    Zero Hedge

    Do Not Panic!! This is orderly...

    The current decline in the high yield market, now at 30 trading days, has been the fastest since the end of the 2008 recession, with yields widening 159 bp. Only the July - October 2011 market decline had a greater ultimate magnitude than the current period.

    As we noted here:

    Remember - and it's important - there is no rotation that drives high-yield credit spreads wider without punishing equities. They are liabilities on the same capital structure and rise and fall in a highly correlated (well non-linear co-dependence) manner as the underlying business risk rises and falls.

    Do not, repeat do not, see high yield credit weakness as a sign of rotation to stocks - if the credit cycle has turned then stocks are set to fall. And bear in mind that while HY yields are at all-time lows, spreads are not and in fact being short stocks relative to credit makes more sense if you are you are a bear on the credit cycle here.

    The only problem being that the epic flows that sustained a credit market at non-economic levels for so long will exit in a hurry.

    Panafrican Funk...

    http://seekingalpha.com/article/1521072-s-p-500-stock-dividend-yields-vs-10-year-treasury

    Pretty good article showing the collapse of the stock div arb. Dividend stocks are going to get fucking pummeled.

    http://www.fool.com/investing/dividends-income/2013/06/25/will-dividend-paying-stocks-fall-more-than-the-mar.aspx

    Yes, there are occasionally people on the Fool that are not completely stupid.

    nope-1004
    The big indicator prior to the 2008 market meltdown was the corporate bond market. Appears to be happening again, but will this time be different? Dunno.
    cougar_w

    Please do not worry. 10 yr. creepin' to 2.61 currently.

    HYD Crosses Critical Technical Indicator

    ETFChannel.com

    In trading on Tuesday, shares of the High-Yield Municipal Index ETF (AMEX: HYD) entered into oversold territory, changing hands as low as $32.08 per share. We define oversold territory using the Relative Strength Index, or RSI, which is a technical analysis indicator used to measure momentum on a scale of zero to 100. A stock is considered to be oversold if the RSI reading falls below 30.

    In the case of High-Yield Municipal Index, the RSI reading has hit 22.9 — by comparison, the RSI reading for the S&P 500 is currently 54.3.

    A bullish investor could look at HYD’s 22.9 reading as a sign that the recent heavy selling is in the process of exhausting itself, and begin to look for entry point opportunities on the buy side.

    Looking at a chart of one year performance (below), HYD’s low point in its 52 week range is $31.42 per share, with $33.57 as the 52 week high point — that compares with a last trade of $32.10. High-Yield Municipal Index shares are currently trading down about 2% on the day.

    Gross Says Reduce Risk Assets Since QE Not Boosting Growth by By Liz Capo McCormick

    June 04, 2013 | Businessweek

    Pacific Investment Management Co.’s Bill Gross, manager of the world’s biggest bond fund (PTTRX), said the Federal Reserve’s zero-bound interest rate policy and quantitative easing programs are becoming more of a problem for an economy that needs structural reforms.

    The Fed’s polices are “desperately attempting to cure an economy that requires structural as opposed to monetary solutions,” Gross wrote in his monthly investment outlook posted on Newport Beach, California-based Pimco’s website today. “Central banks -- including today’s superquant Kuroda, leading the Bank of Japan -- seem to believe that higher and higher asset prices produced necessarily by more and more QE check writing will inevitably stimulate real economic growth via the spillover wealth effect.”

    The Fed is purchasing $85 billion a month in Treasuries and mortgage debt as part of its third round of quantitative easing, which began after it dropped its benchmark rate to almost zero to lift the economy out of recession. The central bank cut its target rate for overnight loans to a range of zero to 0.25 percent in December of 2008.

    Global Stimulus

    Haruhiko Kuroda, governor of the BOJ, is pursuing unprecedented stimulus to jolt Japan out of deflation. The European Central Bank cut its benchmark rate by 0.25 percentage point to a record 0.5 percent on May 2, and speculation has mounted that the Bank of England will increase its bond-buying target after Mark Carney takes over as governor next month.

    The Fed holds more than $3 trillion in assets on its balance sheet as a result of three rounds of quantitative easing, up from about $900 billion in 2007.

    “Low yields, low carry, future low expected returns have increasingly negative effects on the real economy,” Gross wrote. “Credit expansion in the private economy is restricted by an expanding Fed balance sheet and the limits on Treasury” repurchase agreements.

    Gross advised investors reduce risk and carry-related assets, referring to assets that have a higher perceived risk than securities such as Treasuries or longer-term debt.

    Past Predictions

    Gross said May 16 that fixed income’s three-decade bull market “was over.” He said on May 31 that Pimco likes Treasuries (USGG10YR) that mature in five to 10 years, as there will be “no tapering for now.”

    Yields on 10-year Treasuries rose 46 basis points in May, including a jump of 16 basis points, or 0.16 percentage point, on May 28, as a report showing consumer confidence climbed to the highest in more than five years bolstered speculation the Fed would scale back its purchases. Gross’s Pimco Total Return Fund (PTTRX), the world’s largest mutual fund, declined 1.9 percent in May, the biggest monthly loss since September 2008.

    The performance (PTTRX) of the $293 billion Total Return Fund puts it behind 94 percent of similarly managed funds through May 30, according to data compiled by Bloomberg. The fund’s allocation to Treasuries has hindered performance as government-debt securities declined.

    U.S. government debt tumbled 2 percent last month, the most since December 2009, according to Bank of America Merrill Lynch indexes. Employment gains and increases in housing and consumer confidence suggested the recovery in the U.S. economy, the world’s largest, is gaining momentum.

    Global bond markets posted their biggest monthly losses in nine years in May. The Bank of America Merrill Lynch Global Broad Market Index, which tracks more than $40 trillion of bonds, fell 1.5 percent.

    Gross raised the holdings of Treasuries in his flagship fund to 39 percent as of April 30, the highest level since July 2010, from 33 percent as of March 31. He’s increased the proportion of U.S. government securities every month this year since February. In 2011, Gross’s fund lost an estimated $5 billion to withdrawals, according to Morningstar Inc., after he eliminated U.S. Treasuries early in the year and missed a rally.

    Pimco, a unit of the Munich-based insurer Allianz SE, managed $2.04 trillion in assets as of March 31.

    To contact the reporters on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net

    To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

    [Jun 01, 2013] Junk Bond Volume Piling Up, but Trouble Lurks

    Trouble really lurks...
    Yahoo! Finance

    Junk bond issuance is at record highs this year-and thus at the greatest danger should yields start rising.

    Companies around the world have issued $254 billion in high-yield debt this year, a number that includes $130.6 billion from the U.S., according to the latest numbers from Dealogic.

    Global issuance is up a stunning 53 percent from the same period in 2012 and has accounted for 9 percent of the total deals in the debt capital markets space-also a record and fully one-third higher than last year's pace.

    The U.S. issuance has increased 24 percent over the previous year. Record issuance also has come from the U.K., China, Russia-and debt-plagued Italy, which despite being at the center of the European sovereign debt crisis has seen $7 billion hit the junk bond market this year, Dealogic said.

    Because junk bonds have a history of trading in tandem with the stock market , it's not a big surprise to see issuance swell.

    The Standard & Poor's 500 (^GSPC) has surged nearly 16 percent this year, and the high-yield market has followed. The Barclays U.S. Corporate High Yield Index returned 4.75 percent through April.

    But with investors beginning to fear that the Federal Reserve may stage an early exit from its monetary stimulus programs, fears are growing that junk bonds could take a hit.

    "On the surface, things look pretty good in the high yield market," Citigroup analysts said in a report. "Digging a little deeper, however, we see some troubling signs."

    All that supply is beginning to take a toll on the secondary market-where those who buy the bonds from issuers go to trade them-and there are signs that demand is waning.

    The two leading exchange-traded funds for junk-the SPDR Barclays High Yield Bond (JNK) and the iShares iBoxx $ High-Yield Corporate Bond (HYG)-sustained a combined $660 million in outflows last week, the second-worst of any class after emerging markets, according to IndexUniverse.

    Mutual funds saw a similar trend, with $581 million in high-yield redemptions, the worst week since November, according to Thomson Reuters.

    Citi said the monthly total looks like it will be the largest high-yield selling since at least November 2008.

    Where the market goes from here is likely dependent on the Fed.

    Some Open Market Committee members indicated at the last meeting that a gradual decrease of the central bank's $85 billion a month in purchases of Treasurys and mortgage-backed securities would be warranted as early as June.

    In response, Treasury yields have jumped upwards, and some firms-Goldman Sachs, in particular-are asserting that these could be the early days of the bond bull market's demise.

    "We've been bullish on high yield since September and will not change our view based on these developments, because we believe the market has overreacted to the Fed's comments," Citi said. "They highlight, however, the challenge for the FOMC and the risk of a policy misstep."

    The biggest potential misstep: A move by the Fed that would startle markets, push investors away from riskier bonds and send yield spreads wider.

    All that issuance suddenly would find a tougher marketplace, driving up yields and making borrowing for lower-credit companies significantly more expensive from the current yields which slipped below 5 percent in May.

    Citi said the exodus from high-yield has been due to "an expectation of faster liquidity withdrawal from the Fed" and warned that "as this occurs, capital flows are likely to turn negative, in our view, thereby limiting access to funding and maybe even increasing default concerns."

    [May 27, 2013] Economic reality finally cracks market fervor

    That can spell troubles for junk. Vanguard junk bond fund lost more then 1% during the last week.

    As evidence mounts that a mid-year slowdown is taking place in the world economy, the next few days will offer a clearer glimpse of how that will impinge on policymaking and buoyant financial markets.

    ... ... ...

    Some poor business surveys from China have also had an impact, suggesting the world's No.2 economy is struggling for momentum.

    ... ... ...

    "The underlying momentum in the global economy is weaker than it should be at this point of the economic cycle, five years after the global crisis," said Lena Komileva, director of G+ Economics consultancy in London.

    "We have yet to see evidence of a convincing, self-sustained positive feedback loop between real growth and market value inflation."

    ... ... ...

    Growth is still proving to be elusive for the euro zone economy, largely thanks to the extent of the budget austerity taking place across the continent.

    ... ... ...

    [May 01, 2013] Pimco’s Gross: High-Yield Defaults Are Coming, Just A Question of Extent By Michael Aneiro

    Pimco Gross is systematically saying that. Most often he was wrong.
    March 5, 2013 | Barrons.com

    Pimco‘s Bill Gross was on Bloomberg TV today, where he was asked whether junk-bonds – currently yielding 5.81% on average at a spread of 4.98 percentage points over Treasuries – continue to make sense if risk premiums fall further given the market’s inherent risk. Here’s Gross:

    Are [spreads] less rational at 4 or 3 [percentage points]? Certainly. We know, and history would prove that in the high-yield market that as the exuberance follows through, that defaults begin to increase. That’s one of the pieces of the puzzle that Jeremy Stein, the Fed governor, pointed out in his paper where he spoke to irrational exuberance. So defaults are coming, it’s just a question of how extensive they are. And if they’re only at a 2-3% pace, which is where they are now, and if you get a normal recovery, then you’re still left with a 3-4% return at today’s levels. If you squeeze it a little bit more, then you’re getting closer to that cash [return] number, that is really a point of little return.

    [Mar 03, 2013] Ketchup, not blood, on the trading floor By Spengler

    Are we back to 2006 or are we back to 2004 and still have two years of growth? Expectations are much gloomier than they were in 2007. US economic growth is crawling along in the 1%-2% range, and was negative during the fourth quarter of 2012. That create additional risks for junk. The key question is "when?".
    Asia Times

    ... We could think of that as the yield on fixed-interest investments which compete with equities, or - more realistically - as the borrowing cost to buy corporate cash flows.

    That has come down to the lowest level in history, thanks to the Federal Reserve. It costs junk-rated single-B borrowers only 6% on average to issue new 10-year debt. It's hard to compare the yield on single-B securities with prospective earning s on stocks. Single-B borrowers are likely to default. The time value of money argument becomes confusing because the future default rate is unknown.

    But if you are a private equity fund buying a traded company, as Brazil's 3G Capital and Warren Buffett bought Heinz last week, the likelihood of default has a totally different meaning: that's the likelihood that you will default to people who lent money to you. As much as it hurts to default, it hurts a lot more to be on the receiving end of a default. As one industry giant told me years ago: "High yield bonds are there to be sold, not bought."

    Exhibit 5: Junk bonds at lowest yields on record

    Why are junk bond yields at all-time lows? There are two big reasons. The first is that the economy has been more cartelized, less entrepreneurial and less risky. The bad news is always someone's good news. During the 1990s, disruptive new technologies turned a lot of stable franchises to junk - literally, in the case of some telephone company bonds. The Facebook misfire and Apple's fall from grace point up the sclerotic character of the economy. No-one need worry about entrepreneurial challengers. They have nothing to do with the price of ketchup.

    And the second is that the Federal Reserve has vacuumed up a vast amount of risk into its own portfolio (by purchasing longer-term Treasuries and mortgage-backed securities), leaving the market chronically short of yield.

    Private equity firms can borrow at the lowest yields on record and lever up the earnings of stable corporations like Heinz, extracting the difference between the cost of financing and the levered earnings yield. That makes the equity of predictable companies like Heinz valuable.

    [Mar 02, 2013] 3 Must-See Charts On The Raging Bull Market In Junk Bonds

    Early last month, Fed Governor Jeremy Stein gave a speech titled Overheating in Credit Markets: Origins, Measurement, and Policy Responses that raised the question of whether or not we might be seeing a bubble, and if so what might be done about it.

    You've probably heard a lot of talk about the aggressive lengths that money managers are going to to "reach for yield" in the context of this ultra low-rates environment.

    Stein didn't sound too fearful yet, but the overall concern is that we could be setting up another credit bubble, just like before the recent crash.

    In the latest version of their US Interest Rates Strategist letter, Morgan Stanley's Vincent Reinhart and Matthew Hornbach look at the scene in corporate credit and determine that the market might be "modestly rich" rather than straight-up "overheated."

    Three charts from their work stand out, that nicely call into question the idea of a bubble.

    First, although junk bond (or high-yield) yields are at record lows, actual spreads (where those yields are relative to risk-free Treasuries) remain well off their lowest levels.

    The chart is a little bit noisy for the unfamiliar, but the line to watch here is the green line, which shows the average high-yield spread, or the average difference between what high-yield credit pays and what risk-free Treasuries pay. The current difference is about 500 basis points, well above the less then 300 basis points that we saw pre-crisis.

    The next chart shows what companies are doing with the proceeds of their high-yield borrowing. Whereas in 2007, high-yield debt issuance was going to things like leveraged buyouts and other acquisitions, these days the proceeds are going overwhelmingly to refinance old debt, which is just really prudent financial management.

    And then finally, the underlying condition of high-yield debt issuers is in better shape these days. They have more cash relative to debt, suggesting that their credits are fundamentally safer.

    None of this is to suggest that there aren't causes for concern. And you should read Jeremy Stein's speech (here) but the evidence of a raging bubble in this space has to be tempered by signs that prices aren't totally out of whack, and issuers of high-yield debt aren't going crazy.

    [Feb 27, 2013] Bill Gross: Credit Markets ‘Somewhat Exuberantly’ Priced By Patrick McGee

    Return 3% from high yield means 3% fall in bond prices. For VWEAX that means target price for the year at $5.91. Please note that Gross record as a forecaster is dismal. He often was too early in his call. Sometimes two or three years too early.
    February 27, 2013 | WSJ.com

    “On a scale of 1-10 measuring asset price ‘irrationality’, we are probably at a 6 and moving in an upward direction,” Gross writes in his March investment outlook. “Corporate credit and high yield bonds are somewhat exuberantly and irrationally priced. Spreads are tight, corporate profit margins are at record peaks with room to fall, and the economy is still fragile.”

    But Mr. Gross doesn’t recommend selling en masse, only lowering return expectations. After double-digit returns on junk bonds last year, he says 3%-to-4% returns are more likely this year. Prices are too high and yields are simply too low for the market to continue delivering such high returns.

    Mr. Gross—often dubbed “the Bond King”—spends much of his March outlook referring back to a Feb. 7 speech from Federal Reserve governor Jeremy Stein, who expressed concern that “we are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit.”

    For Mr. Gross, those comments harked back to the famous “irrational exuberance” talk in 1996 from former Fed chief Alan Greenspan. Now, as then, the market is trying to determine whether certain assets are overvalued and what to do about it.

    His conclusion: be cautious.

    “We join with Governor Stein and perhaps Alan Greenspan in encouraging not an exit but a reduced expectation,” he says. “Be rational, be optimistic if so inclined, but temper it with a commonsensical conclusion that we have seen something similar to this before, and that previous outcomes seldom matched the exuberance.”

    Mr. Gross’s comments come a day after Fed chairman Ben Bernanke weighed in on the question of overheated markets in his speech to Congress on Tuesday. “Although a long period of low rates could encourage excessive risk-taking … we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation,” the chairman said.

    [Feb 14, 2013] Slide of Vanguard High-Yield Corporate Adm (VWEAX) continues, Feb 11 closing is $6.08

    I wonder what will be the price on May 1 ? Historically prices above $6 were high.

    The value of 200 days average is 5.99 or $.09 below the value on Feb 11 closing. 1000 days average is 5.58.

    [Feb 08, 2013] Is drop of VWEAX to 6.09 from 6.15 a sign of tough times ahead for junk?

    It is still slightly above 200 days average...

    At the beginning of 2004 (also four years from previous recession, junk dropped from 6.40 to 6.15. After then it went downhill to 3.90 in December 2008.

    [Feb 7, 2013] Fed Worried about Bubbles, Not Inflation

    Economist's View

    Binyamin Appelbaum:

    Fed Official Sees Tension in Some Credit Markets, by Binyamin Appelbaum, NY Times: Some credit markets are showing signs of overheating as investors take larger risks in response to the persistence of low interest rates... Fed Governor Jeremy Stein, highlighted a surge in junk bond issues, the popularity of certain kinds of real estate investment trusts and shifts in bank balance sheets as areas the central bank is watching closely...
    Mr. Stein gave no indication that the Fed is contemplating any change in its aggressive efforts to hold down interest rates. Rather, he described the overheating as a trend that might require a response if it intensified over the next 18 months. But the speech nonetheless underscored that the Fed increasingly regards bubbles, rather than inflation, as the most likely negative consequence of its efforts to reduce unemployment by stimulating growth. ...
    Central bankers historically have been skeptical that asset bubbles can be identified or prevented from popping. Moreover, they tend to regard financial regulation as the appropriate means to prevent excessive speculation and not changes in monetary policy ... But the crisis has forced central bankers to reconsider both the importance of financial stability and the role of monetary policy. ...
    And he closed on a cautionary note. “Decisions will inevitably have to be made in an environment of significant uncertainty,” he said. “Waiting for decisive proof of market overheating may amount to an implicit policy of inaction on this dimension.”

    With fiscal policy moving in the wrong direction -- deficit reduction rather than employment enhancing stimulus, e.g. infrastructure -- if monetary policymakers begin getting skittish, then the unemployed will lose the one institution that seemed to actually care about their struggles. Not good.

    [Feb 02, 2013] Junk Bonds Not So Junky Anymore by Kenneth Rapoza, Contributor

    "In fact, for the third year in a row the default rate for non-investment grade bonds stood at 1.9 percent"
    Jan 28, 2013 | Forbes

    Junk bonds: talk about an awful description for non-investment grade debt. And we all thought B’s an high C’s in school were above average.

    In some cases, they are.

    The ugly junk bonds of old have now become the more palatable high yield bonds of today. In a low interest rate environment like we have now, high yield is a Godsend. These companies are high yield for a reason, of course. Their debt is riskier. Credit analysts look at the corporate balance and income sheets and gauge whether or not a company has enough money to cover its short term maturing debt while paying interest on its long term loans, and still manage to grow as a company. Those who can barely cover it are always considered high yield.

    Yet, high yield issuers are doing pretty good as an investment class.

    In fact, for the third year in a row the default rate for non-investment grade bonds stood at 1.9 percent, Fitch Ratings said Monday in a special report. That’s higher than the 1.5 percent default rate last year, but still well below the historic average default rate of 4.9 percent.

    Thirty-two issuers defaulted on $20.5 billion in bonds last year, compared with 29 issuers and $15.9 billion in 2011. The year produced a considerable number of large defaults, though, including bankrupt firms like Edison Mission Energy ($3.7 billion), Residential Capital ($2.8 billion), ATP Oil and Gas ($1.5 billion) and struggling names like Energy Future Holdings ($1.8 billion), also on the cusp of Chapter 11.

    Fitch Ratings projected that the default rate in 2013 will be similar to last year’s. If Energy Future Holdings goes under, then it could push the rate up higher due to the company’s size. Plus, with the U.S. economy still running on easy money, the constructive outlook for defaults is heavily dependent on steady, if not, stellar macro conditions, today’s report stated. Fitch is projecting U.S. GDP growth of 2.3 percent in 2013, assuming political discord in Washington does not have a material impact on the economy.

    Fitch believes that the default rate on high yield debt would “at least double if the economy slides back into recession or very low growth.”

    Junk bond funds have been relatively quiet this year. State Street’s $40 billion Barclays High Yield Bond (JNK) exchange traded fund is up 1.58 percent year-to-date ending, while the S&P 500 is up 5.3 percent. By comparison, JNK is beating the Barclays 3-7 Year Treasury Bond Fund (IEI), which is down 0.5 percent year-to-date. Over the past 12 months, the JNK bond ETF rose 4.79 percent to IEI’s 0.4 percent “low yield/risk-free” gain.

    Last year’s riskiest sectors were the paper and pulp industry (7.7% default rate), utilities (10.5%), consumer products (4.7%), transportation (4.4%) and banks (3.3%).

    High yield issuance topped $300 billion in 2012. The majority of that was used to refinance existing debt and by the end of 2012, 80 percent of market volume ($1.13 trillion) consisted of bonds sold since 2009. Beyond pushing out debt maturities last year, high yield borrowers in 2012 saw a decline in their interest rates as demand for their bonds rose. Higher demand for bonds, means higher bond prices. Higher bond prices, of course, means lower interest rates for the one’s issuing the debt. The weighted average interest rate offered slipped to 7.99 percent from a higher yielding 8.27 percent at the beginning of 2012. As a result, issuance began to move more aggressively down the rating scale as companies felt they had a better chance to find a lender at lower cost. From July to year-end, the volume of ‘CCC’ rated new bond issues rose 54 percent and made up 18 percent of overall junk bond issuance.

    The Junk in JNKs Trunk

    Company Sector Coupon*

    HCA Holdings Healthcare services 6.5%
    Sprint Nextel Telecommunications 9.0%
    First Data Business services 12.62%
    Energy Future Utilities 10%
    Samson Investment Co. Energy 9.75%
    Community Health Sys Healthcare services 8.0%
    Ally Financial Banking 8.3%
    FMG Resources Metals & mining 7.0%
    Everest Acquisition Oil & gas 9.37%
    Dish DBS Broadcasting services 6.75%

    Source: Morningstar.

    *Coupon, for the non-bond lords among us, is the yield offered at issuance. Current yield almost always differs from the coupon rate as bond prices fluctuate.

    [Feb 02, 2013] 4 Reasons the Junk Bond Rally Will Continue in 2013 by Marc Prosser

    I doubt about "will". See Marc Prosser LinkedIn before jumping on those recommendations.
    Jan 26, 2013 | Forbes

    Earlier this month, the yield on the average junk bond dropped below 6% for the first time ever. Because of this, many investors think that yields can’t go any lower and that interest rates will reverse in 2013.

    Here’s four reasons why they are wrong:

    Reason number 1: Junk bond credit spreads are not anywhere near all time historical lows.

    In addition to the interest rate a particular type of bond (ie. high yield, investment grade etc) is paying, bond traders will look at how that rate compares to treasuries. This comparison enables traders to understand if a category of bonds is expensive or cheap given the current level of overall interest rates.

    The below chart shows the difference in yield between the average high yield bond, and a treasury of the same maturity. This is what is known as the high yield credit spread. (You can learn more about credit spreads here.)

    As you can see from the above chart, while junk bond yields are at all time lows, the high yield credit spread is nowhere near an all time low. In fact, there were two extended periods of time since 1996 (which is as far back as the Fed’s data goes), that the high yield credit spread was around 2.5%. This means at its current level of 5%, the high yield credit spread would have to drop another 2.5% before hitting a new all time low.

    Reason Number 2: Corporate Default Rates are near an all time low

    As you can see from the below chart, the average default rate on corporate bonds is around 4%. That compares to the current default rate of around 1.1%. So, while junk bond yields are at historic lows, so is the corporate default rate.

    Reason number 3: Yield starved bond managers are going to start to leverage up.

    This one I got from a recent presentation by bond guru Jeffrey Gundlach. In his view the Junk bond market is not yet in a bubble. Normally, a bubble is partially caused by investors increasing their leverage, which has not yet happened. He does think however that bond managers are going to start adding leverage to try and juice whatever yield they can out of this low yield environment.

    When this happens it will have the same effect as if a lot of new money and demand was coming into the market. While this will likely inflate a junk bond bubble in the future, it is likely to send yields even lower in the near term. A recent article in the Wall Street Journal confirms that this is already starting.

    Reason number 4: Everyone thinks there is a bubble in junk bonds.

    Learn Bonds publishes a piece called The Best of the Bond Market, where we link to all the best bond market stories from around the web each trading day. There have been so many stories about the “bubble in junk bonds” that I have had to tell the writer to start leaving some of them out. If we included them all then half the stories in the piece would be the same story calling for a bubble in junk bonds.

    From my experience when everyone thinks a market is going to go in one direction, that market has a nasty habit of heading in the exact opposite direction.

    For another idea on how to increase yields in this low yield environment read our article Dividend Investing for Bond Investors here.

    Betting On High Yield Bonds To Beat Equities In 2012

    Forbes

    When you invest in risk, you want the reward, right? Yet, emerging market and high yield bonds in general have underperformed safety all year. The trend, says David Sherman, manager of the RiverPark Short Term High Yield (RPHYX) bond fund could be drawing to a close.

    “Although the high yield market sentiment often is correlated to the equity market, the space has gotten very beaten up. Unless Europe and the U.S. address their balance sheets and provide world leadership to rebuild confidence, I suspect high yield will outperform equities over the next 12 months,” Sherman says.

    “Investors can earn a yield-to-maturity on an average duration of around 3 years in high yield in excess of 12% on a diversified portfolio rated B/B- with Debt/EBITDA of under 4.5 times,” he says.

    The Merrill Lynch High Yield Master II Bond Index ended the third quarter down 1.69%, the worst quarterly performance since the third quarter of 2008 and the fourth worst performing quarter since September 1986.

    The risk trade had investors pouring into Treasury bonds. Outflows of high yield bonds and ETF funds totaled $10.4 billion in August and September, roughly 0.34% of the market’s actual size, according to Lipper.

    As a result of the sell-off in the quarter, Sherman thinks high yield is now undervalued given the current low interest rate environment. Plus, a weak outlook in the U.S. and Europe, coupled with slower growth in China, means the global economy will likely “muddle through” the next 12 months, making high yield bonds a defensive investment class with equity like upside, Sherman says. In a worst case scenario, such as a double dip recession, high yield would get clobbered.

    High yield bond spreads soared in 2008 by more than 400% to more than 700 basis points over Treasurys before declining in 2009. Spreads over Treasurys is now around 170% of the TSY yields. Last month, average interest rates on high yielding corporate debt stood at 8.84% compared to 1.9% for 10 year TSYs.

    “I don't like Treasurys, but that doesn’t mean U.S. government bond prices will continue to retreat,” he says. Ten year bond prices have fallen below par after trading well into the 120s for all of September.

    “It is hard to fight the Fed and herd behavior. We had a pretty significant short on 10 year Treasurys, which we ultimately threw in the towel. I shorted the Treasury yield thinking lack of political leadership from Washington, the U.S. debt ceiling, and the general continued deterioration of the U.S. balance sheet would demand a higher real interest rate by lenders. I was surprised that after S&P downgrade, the UST rallied,” he said.

    Bank of America bonds. While an advocate of high yield corporate debt, Sherman warns investors away from Bank of America bonds yielding over 5%. “I wouldn’t touch them just from a fundamental risk versus reward perspective,” he says.

    Bank of America takes credit, trading, and operating risk every day and employs significant leverage. Any tiny mistake is magnified. I don’t like the idea of being at the bottom of the capital structure since depositors are senior to me in which I make limited upside but the downside is horrible. Maybe an interesting stock investment because you enjoy the spoils of success with similar downside risks as bondholders. But as a bondholder with a capped upside on a financial institution business model, ‘no thank you’.”

    See: For Fixed Income Investors, Another Way To Beat Treasurys

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