Displaying items by tag: junk
Investors seem to have every reason to worry about bonds. Prices are high, yields are low, and low quality companies are accessing easy financing even in the face of an uncertain economic future. With all that said, there might not be any reason to worry at all. Central banks are still gaming the system. From the Fed being really conservative with rates, to the ECB and BOJ doing massive QE, the whole central bank mechanism is conspiring to prop up bond prices in a major way.
FINSUM: As long as that pre-condition of huge central bank support is in place, it is hard to see bonds taking much of a hit.
The media is currently doing its level best to scare junk bond investors. There have been many analyst and media warnings lately about the pending fall of high yield bonds (some of which we have featured). Most argue that in an economic downturn, BBB bonds will suffer. Others says there has been no rise in underlying performance to justify the rise in prices. Others have focused on CCCs and their movements. Initially the worry was that CCCs had not rallied like the rest of the market, which was taken as a sign of deteriorating credit conditions. Now the media is warning (see Barron’s) that since they have rallied, it is again a warning sign.
FINSUM: Everything is a warning sign! Our own feeling is that we are generally moving toward a more risk-on environment and the trend for high yield is improving as the economic outlook does.
One of the biggest ratings agencies on Wall Street has just put out a stern warning on the junk bond market. Moody’s says that high yield debt may fall “significantly” after a big rally this year. In a quote that captures the general disbelief that has accompanied the junk bond rally this year, Moody’s economist John Lonski says ““High-yield bonds have rallied mightily despite the lack of any observable broad-based acceleration of either business sales or corporate earnings”. Moody’s thinks that if performance of the underlying companies in the space does not improve, then there will be a reckoning, saying ““If the anticipated improvement in the fundamentals governing corporate credit quality do not materialise, a significant widening of high-yield bond spreads is likely”.
FINSUM: Irrational exuberance?
There are some very worrying signals coming out of the high yield sector. In particular, stocks at the riskiest end of the market have been underperforming. Bonds rated CCC, CCC+, and CCC-, which are the three lowest rungs before default, have been underperforming all year and that weakness has now reached an “unprecedented size”. What is worrying is that very lowly rated bonds are usually the most influenced by economic perceptions, and it is unusual that with junk rallying so much this year that this cohort has not taken part.
FINSUM: So there are two options for what this could mean. Either it means investors are just being cautious, or much more negatively, that credit conditions are tightening, which would be a sign of a pending economic downturn.
One corner of the bond market, or rather credit market, is having a tough time and it may be a negative sign for the rest of fixed income. CLOs, or collateralized loan obligations, which have been a star for several years, recent tumbled. In aggregate, CLOs dropped 5% in October, and those close to the market see more volatility to come. According to Citigroup “We think there’s more volatility coming … We recommend investors reduce risk and stay with cleaner portfolios and better managers”. CLOs are a key funder of the leveraged loan market, and weak demand there can flow through to boost borrowing costs to all corporates.
FINSUM: This is akin to a warning coming out of the high yield market, as what it reflects is worries about how leveraged companies might handle a downturn.