Junk Bonds For 401K Investors
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
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 --
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.
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)
- In no way information in the table below represents investment advice. You can lose money following
this strategy, especially on long decline periods.
- There is no scientific basis for the strategy presented.
- Simple strategies do not guarantee success and probably can't beat others possibly including
buy-and-hold, but at least prevent drastic losses during abrupt slump, which is important for junk
which can drop 50% from the top or more.
Interest rate (annualized)
Spread with 10 year treasuries
200 days Average
Days above/below 200 days average
Deviation from 200 days average
- [Dec 10, 2014] 65 day below simple 200 days average.
- Winter for high yield might be coming after six years of gains.
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.
- Governor Stein’s paper, accompanied by correlations from Bianco Research, suggests caution in
today’s high yield market (PIMCO
Investment Outlook - Rational Temperance)
- 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.
- 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.
- Junk Bonds Whipsawed as Trading Drought Rattles Investors ( Nov 21, 2014 | Bloomberg )
- Should you sell stocks Check junk bonds first ( Nov. 30, 2014 | money.cnn.com )
- Oil Market Reminds Me of 1986 Price Drop Sass ( finance.yahoo.com )
- Richard Lehmanns 6% Solution Finding Gems Among Junk Bonds
- Vanguard junk drops below 200 days simple average...
- High Yield Credit Market Flashing Red As Outflows Surge ( 07/25/2014 | zerohedge.com )
- April this year on the danger of junk bonds ( 2014-04-30 | Bloomberg )
- Junk Bonds: Not Worth the Risk ?
- Wolf Richter: Bubble Trouble: Record Junk Bond Issuance, A Barrage Of IPOs, “Out Of Whack” Valuations, And Grim Earnings Growth
- Remember When Republicans Were Worried about Uncertainty ( Economist's View )
- High yield bonds, the pain continues and will only get worse ( Market Realist )
- For Bonds, Its A Lehman Repeat ( Zero Hedge )
- HYD Crosses Critical Technical Indicator ( ETFChannel.com )
- Gross Says Reduce Risk Assets Since QE Not Boosting Growth by By Liz Capo McCormick ( June 04, 2013 | Businessweek )
- Junk Bond Volume Piling Up, but Trouble Lurks ( Yahoo! Finance )
- Economic reality finally cracks market fervor
- Pimco’s Gross: High-Yield Defaults Are Coming, Just A Question of Extent By Michael Aneiro ( March 5, 2013 | Barrons.com )
- Ketchup, not blood, on the trading floor By Spengler ( Asia Times )
- 3 Must-See Charts On The Raging Bull Market In Junk Bonds
- Bill Gross: Credit Markets ‘Somewhat Exuberantly’ Priced By Patrick McGee ( February 27, 2013 | WSJ.com )
- Slide of Vanguard High-Yield Corporate Adm (VWEAX) continues, Feb 11 closing is $6.08
- Is drop of VWEAX to 6.09 from 6.15 a sign of tough times ahead for junk?
- Fed Worried about Bubbles, Not Inflation ( Economist's View )
- Junk Bonds Not So Junky Anymore by Kenneth Rapoza, Contributor ( Jan 28, 2013 | Forbes )
- 4 Reasons the Junk Bond Rally Will Continue in 2013 by Marc Prosser ( Jan 26, 2013 | Forbes )
- Betting On High Yield Bonds To Beat Equities In 2012 ( Forbes )
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
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.
"That swing away from junk bonds often happens shortly before stock market downturns. "
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.
(Video). Looks like his view is that the economy is entering period of high turbulence...
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.
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
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.
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?
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
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
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
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 ?
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.
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,"
High yield credit markets are majorly diverging
"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 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.
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.”
... ... ...
“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
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
[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
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist,
and author, with extensive international work experience. Cross posted from
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
“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
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.
susan the other
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
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.
Right. And it is still just as terrifying to know that history dictates, proves, that we
are all totally nuts.
The market is forward looking in pricing positive or negative delusions.
I regularly look at page 21 of this report:
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.
Code Name D
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.
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.
…”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?
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
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.
susan the other
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
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.
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)!
“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
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?
“The Fed Winged It”
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
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.
DIY QE education via “Quantitative Easing Explained” with 5.6 million views since 11/2010!
And “Quantitative Easity Revisited”
I wonder if NC readers find anything false in these.
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
As for the last part of your question… I have…. no clue.
“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.
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.
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
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
This will all end in tears.
Something about rumor control a la Jim Rickards and any next event requiring an IMF SDR thingy…
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.
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
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
As Ben Inker at GMO has written, this hope is justified only if the majority of American
willingly embrace serfdom.
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.
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.
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
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?
(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
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
I wonder if Dimon and Obama will notice that ginormous bubble in the market?
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
Shutdown? What shutdown?
Fred C. Dobbs
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.
(True Believers are always Right.)
Conservatives With a Cause: ‘We’re Right’
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.”
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
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.
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 |
(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
"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
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
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: email@example.com)
Subscribe to WSJ: http://online.wsj.com?mod=djnwires
"There is no rotation that drives high-yield credit spreads wider without punishing equities"
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.
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.
Pretty good article showing the collapse of the stock div arb. Dividend stocks are going
to get fucking pummeled.
Yes, there are occasionally people on the Fool that are not completely stupid.
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.
Please do not worry. 10 yr. creepin' to 2.61 currently.
HYD Crosses Critical Technical Indicator
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
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
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.
Pacific Investment Management Co.’s Bill Gross, manager of the world’s biggest bond
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
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.
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.
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
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
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
To contact the reporters on this story: Liz Capo McCormick in New York at firstname.lastname@example.org
To contact the editors responsible for this story: Dave Liedtka at email@example.com
Trouble really lurks...
Junk bond issuance is at record highs this year-and thus at the greatest danger should yields
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."
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
... ... ...
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.
... ... ...
Pimco Gross is systematically saying that. Most often he was wrong.
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.
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
... 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.
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
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
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
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.
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 |
“On a scale of 1-10 measuring asset price ‘irrationality’, we are probably at a 6 and moving
in an upward direction,”
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.
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
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.
"In fact, for the third year in a row the default rate for non-investment grade bonds stood at 1.9
Jan 28, 2013 |
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
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
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
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
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%
*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.
I doubt about "will". See Marc
Prosser LinkedIn before jumping on those recommendations.
Jan 26, 2013 |
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
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.
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
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
“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
Softpanorama hot topic of the month
Insights - Investment Outlook
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