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Too Safe to Fail: Implied Default Rate for European Junk Bond is Negative 1.1% 

November 9, 2017

Apparently, European junk bonds are too safe to fail. Fundstrat Global Advisors’ Thomas Lee says the market-implied default rate for a European junk bond sits at a negative 1.1%.

The market’s expectation for an average European high-yield bond to default on its payments stood at negative 1.1% on Oct. 26, versus a long-term average of a positive 5.8%, according to an analysis released Friday by Thomas Lee, the head of research at Fundstrat Global Advisors, who attempted to demonstrate the pernicious consequences of quantitative easing.

“We see this creating a ‘moral hazard’ which allows bad businesses to borrow money and misallocate. After all, wouldn’t anyone want to borrow money at cost of debt less than the U.S. government?” said Lee.

But Martin Fridson, chief investment officer of Lehman Livian Fridson Advisors and a veteran high-yield bond analyst, has criticized the principal way money managers and market strategists like Lee calculate the market’s expectations for the default rate, which uses the option-adjusted spread as a jumping-off point. By his own calculations, the default rate for an average European junk bond should be 0.2%, still a very low level.

Fridson, nonetheless, conceded the ECB was one “root cause” for the seemingly stretched valuations seen in the market for European corporate paper.

Debate Over Risk

Depending on your point of view, the implied default rate on European junk bonds is -1.1% or as high a 0.2%.

One hell of an unwind is coming. I wish I could tell you when.

Guess What Happened The Last Time Junk Bonds Started Crashing Like This? Hint: Think 2008

December 9, 2015

Guess What Happened The Last Time Junk Bonds Started Crashing Like This? Hint: Think 2008

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The extreme carnage that we are witnessing in the junk bond market right now is one of the clearest signals yet that a major U.S. stock market crash is imminent.  For those that are not familiar with “junk bonds”, please don’t get put off by the name.  They aren’t really “junk”.  They simply have a higher risk and thus a higher return than other bonds of the same type.  And yesterday, I explained why I watch them so closely.  If stocks are going to crash, you would expect to see a junk bond crash first.  This happened in 2008, and it is happening again right now.  On Monday, a high yield bond ETF known as JNK crashed through the psychologically important 35.00 barrier for the very first time since the last financial crisis.  On Tuesday, high yield bonds had their worst day in three months, and JNK plummeted all the way down to 34.44.  When I saw this I was absolutely stunned.  This is precisely the kind of junk bond crash that I have been anticipating that we would soon witness.

Normally, stocks and junk bonds track one another very closely, but just like before the 2008 crash, they have become decoupled in recent months.  Anyone that even has an elementary understanding of the financial world knows that this cannot continue indefinitely.  And when they start converging once again, the movement could be quite violent.

When I chose to use the word “carnage” to open this article, I was not exaggerating what is going on in the junk bond market one bit.  On Tuesday evening, Jeffrey Gundlach used the exact same word to describe what is happening…

…click on the above link to read the rest of the article…

 

Junk Bonds Under Pressure

November 18, 2015

Junk Bonds Under Pressure 

While the Stock Market is Partying …

There are seemingly always “good reasons” why troubles in a sector of the credit markets are supposed to be ignored – or so people are telling us, every single time. Readers may recall how the developing problems in the sub-prime sector of the mortgage credit market were greeted by officials and countless market observers in the beginning in 2007.

oil rigPhoto credit: Getty Images

At first it was assumed that the most highly rated tranches of complex structured products would be immune, as the riskier equity tranches would serve as a sufficient buffer for credit losses. When that turned out to be wishful thinking, it was argued that the problem would remain “well contained” anyway. After all, sub-prime only represented a small part of the overall mortgage credit market. It could not possibly affect the entire market. This is precisely the attitude in evidence with respect to corporate debt at the moment.

1-HYG weeklyA weekly chart of high yield ETF HYG (unadjusted price only chart) – click to enlarge.

The argument as far as we’re aware goes something like this: there are only problems with high yield debt in the energy and commodity sectors. This cannot possibly affect the entire corporate credit market. We should perhaps point out that in spite of this sectoral concentration, problems have recently begun to emerge in other industries as well (a list of recent victims can be found at Wolfstreet).

The argument also ignores the interconnectedness of the credit markets. Once investors begin to lose sufficiently large amounts of money in one sector, the more exposed ones among them (i.e., those using leverage, a practice that gains in popularity the lower yields go, as otherwise no decent returns can be achieved), will start selling what they can, regardless of its relative merits. This will in turn eventually make refinancing conditions more difficult for all sorts of industries.

…click on the above link to read the rest of the article…

 

Junk-Bond Bubble Implodes Beyond Energy, Deals Scuttled, Yields Soar, Suddenly “Insufficient Demand”

January 27, 2015

Junk-Bond Bubble Implodes Beyond Energy, Deals Scuttled, Yields Soar, Suddenly “Insufficient Demand”

The year 2015 has just started, and already there have been two junk-bond casualties: the first on Thursday, and the second one today. They weren’t energy companies. Energy companies don’t even try anymore. They’ve been locked out. Both deals had to be scuttled because, even at the high yields they offered, there were suddenly no buyers. 2014 had been a harbinger: 17 junk-bond deals for $5.8 billion in total were shelved, most of them during the last four months.

Ever since the Fed unleashed its waves of QE, institutional investors, driven to near insanity by the relentless interest rate repression, have been chasing yields ever lower in a desperate effort to get some kind of return. In the process, junk bonds and leveraged loans boomed and spiraled to such heights that the Fed – which is never able to see any bubbles – and other bank regulators began fretting over a year ago about the risks they posed to “financial stability.” And in December, it was the Treasury that hit the alarm button about leveraged loans [read… Treasury Warns Congress (and Investors): This Financial Creature Could Sink the System].

Now QE Infinity is gone, interest-rate hikes are vaguely shaping up on the horizon, and institutional investors – bond mutual funds, for example – are getting second thoughts.

Junk bond issuance, at $13.4 billion so far this year, is down 32% from the same period in 2014, according to S&P Capital IQ/LCD’s HighYieldBond.com. Lower-rated companies are “forced to pay-up significantly,” explained LCD’s Joy Ferguson. And some of them, like the Presidio Holdings deal today, are having trouble finding any buyers – despite offering a yield of 11% or higher.

…click on the above link to read the rest of the article…

 

Boom Goes The Dynamite: The Crashing Price Of Oil Is Going To Rip The Global Economy To Shreds

January 12, 2015

Boom Goes The Dynamite: The Crashing Price Of Oil Is Going To Rip The Global Economy To Shreds

If you were waiting for a “black swan event” to come along and devastate the global economy, you don’t have to wait any longer.  As I write this, the price of U.S. oil is sitting at $45.76 a barrel.  It has fallen by more than 60 dollars a barrel since June.  There is only one other time in history when we have seen anything like this happen before.  That was in 2008, just prior to the worst financial crisis since the Great Depression.  But following the financial crisis of 2008, the price of oil rebounded fairly rapidly.  As you will see below, there are very strong reasons to believe that it will not happen this time.  And the longer the price of oil stays this low, the worse our problems are going to get.  At a price of less than $50 a barrel, it is just a matter of time before we see a huge wave of energy company bankruptcies, massive job losses, a junk bond crash followed by a stock market crash, and a crisis in commodity derivatives unlike anything that we have ever seen before.  So let’s hope that a very unlikely miracle happens and the price of oil rebounds substantially in the months ahead.  Because if not, the price of oil is going to absolutely rip the global economy to shreds.

What amazes me is that there are still many economic “experts” in the mainstream media that are proclaiming that the collapse in the price of oil is going to be a good thing for the U.S. economy.

The only precedent that we can compare the current crash to is the oil price collapse of 2008.  You can see both crashes on the chart below…

…click on the above link to read the rest of the article…

 

The Scariest Chart For America’s Shale Industry

January 12, 2015

The Scariest Chart For America’s Shale Industry

Back in early November, when we posted “If WTI Drops To $60, It Will “Trigger A Broader HY Market Default Cycle“, it was greeted with the usual allegations of conspiracy theorism, tin-foil hattery and pretty much everything else, except rebutting facts.

Two months later, it was none other than Goldman which threw in the towel on its call from July 28 of 2014 when it said that “the long-awaited global recovery appears to be getting on track, lifting commodity demand” and scrambled to explain overnight that nothing short of a mass default wave within the shale space will end the ongoing collapse in prices, which are driven not by supply/demand fundamentals but by ZIRP, and a generation of junk bond BTFDers, who can’t wait to invest in the latest 10%, 15%, 20% or higher “yielding” opportunity (ignoring that the issuer may default before even one coupon is paid). In other words, those bond holders who wish to blame someone for the collapsing prices of junk bonds, feel free to address them to Ben Bernanke and his successor, who have enabled insolvent companies to live long beyond their viable lifecycle thanks to a zero cost of capital and a generation of traders who no longer know risk.

This is how Goldman’s Currie tongue-in-cheekly explained this dilemma:

[U]nlike physical stress, how low prices need to go is dependent upon the producer’s view of the future and the persistence of the current low price environment. The lower and more persistent the producer views the future pricing outlook, the quicker the restructuring. Given the optimistic nature of the oil drilling business, producer views are unlikely to change until the environment becomes extremely hostile with prices low enough such that survival becomes questionable.

…click on the above link to read the rest of the article…

 

Junk Bonds Are Going To Tell Us Where The Stock Market Is Heading In 2015

December 22, 2014

Junk Bonds Are Going To Tell Us Where The Stock Market Is Heading In 2015.

Do you want to know if the stock market is going to crash next year?  Just keep an eye on junk bonds.  Prior to the horrific collapse of stocks in 2008, high yield debt collapsed first.  And as you will see below, high yield debt is starting to crash again.  The primary reason for this is the price of oil.  The energy sector accounts for approximately 15 to 20 percent of the entire junk bond market, and those energy bonds are taking a tremendous beating right now.  This panic in energy bonds is infecting the broader high yield debt market, and investors have been pulling money out at a frightening pace.  And as I have written about previously, almost every single time junk bonds decline substantially, stocks end up following suit.  So don’t be fooled by the fact that some comforting words from Janet Yellen caused stock prices to jump over the past couple of days.  If you really want to know where the stock market is heading in 2015, keep a close eye on the market for high yield debt.

If you are not familiar with junk bonds, the concept is actually very simple.  Corporations that do not have high credit ratings typically have to pay higher interest rates to borrow money.  The following is how USA Today describes these bonds…

High-yield bonds are long-term IOUs issued by companies with shaky credit ratings. Just like credit card users, companies with poor credit must pay higher interest rates on loans than those with gold-plated credit histories.

But in recent years, interest rates on junk bonds have gone down to ridiculously low levels.  This is another bubble that was created by Federal Reserve policies, and it is a colossal disaster waiting to happen.  And unfortunately, there are already signs that this bubble is now beginning to burst…

…click on the above link to read the rest of the article…

Great Unwind of Oil-and-Gas Junk Bonds to Defund Fracking? | Wolf Street

December 16, 2014

Great Unwind of Oil-and-Gas Junk Bonds to Defund Fracking? | Wolf Street.

The price of oil plunged once again off the chart on Monday and early Tuesday. At one point, West Texas Intermediate traded below $54 per barrel, though it soon bounced off. Crude is down nearly 50% since June. And over-indebted energy companies with cash flows that range from increasingly uncertain to completely demolished are suddenly contemplating just how deep the abyss might be.

The below-investment-grade bonds these risky companies issued with enormous hoopla and hype to fund the shale revolution and offshore drilling projects, lovingly dubbed “junk bonds,” had been sold to investors on the premise that oil would sell for ever increasing prices in the future, with the understanding that this might allow the company to make interest payments on time and raise new debt to pay off the old debt when it matures.

Even the still uncertain economics of fracking – the expense of drilling coupled with the horrendous decline rates – or the potential environmental consequences and subsequent backlash were elegantly shrugged off on Wall Street, given the ever increasing price of oil.

…click on the above link to read the rest of the article…

Today’s Market Contagion: Energy High-Yield Credit Spreads Blow Above 1000bps For First Time Ever | Zero Hedge

December 15, 2014

Today’s Market Contagion: Energy High-Yield Credit Spreads Blow Above 1000bps For First Time Ever | Zero Hedge.

For the first time on record, HY Energy OAS has broken above 1000bps – signifying dramatic systemic business risk in that sector (despite a modest rebound today in crude prices). The energy sector is entirely frozen out of the credit markets at this point with desk chatter that there is no bid for this distressed debt at all and air-pockets appear everywhere as each new trade reprices the entire sector. The broad high-yield ‘yield’ and ‘spread’ markets are now under significant pressure – both pushing to the cycle’s worst levels.

HY Energy weakness is propagating rapidly into the broad HY markets:

This suggests significant weakness to come for Energy stocks:

This cannot end well (unless the Fed decides monetizing crude in addition to TSYs and E-Minis is part of its wealth preservation, pardon “maximum employment, stable prices, and moderate long-term interest rates” mandate…)

Who Will Suffer from a Leveraged Credit Shakeout? | Enterprising Investor

October 31, 2014

Who Will Suffer from a Leveraged Credit Shakeout? | Enterprising Investor.

Of all the noteworthy moments from the 2014 CFA Institute Fixed-Income Management Conference, the bombshell may have been the default call from Martin S. Fridson, CFA.

Fridson, CIO at Lehmann Livian Fridson Advisors, has been a leading figure in the high-yield bond market since it was known as the “junk bond” market — and he sees as much as $1.6 trillion in high-yield defaults coming in a surge he expects to begin soon.

“And this is not based on an apocalyptic forecast,” he assured the audience.

High-yield bonds, typically issued with credit ratings at the bottom of the scale, tend to suffer default surges during troughs in the credit cycle. The first high-yield default surge occurred from 1989 to 1992, and encompassed the collapse of Drexel Burnham Lambert. The second surge ran from 1999 to 2003, following the bursting of the dot-com bubble, and the third happened in the midst of the global financial crisis, from 2008 to 2009.

Fridson suggests the next default surge will be larger than the last three combined. Each surge saw an average annual high-yield default rate above 7% (which, if extended over a multi-year period, can add up to real money).

…click on the above link to read the rest of the article…

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