Something Is Burning In High Yield Corporates
Gordon Long | Dec 24, 2015 06:06AM ET
John Rubino and Gordon T Long discuss the alarming developments in the Junk (High Yield) Bond market. John was warning on his last appearance on Macro Analytics about the things he was seeing, while Gord was warning of a turn he was seeing in the Credit Cycle. Both previous observations have proven correct so John and Gordon postulate what to expect next. It isn't pretty!
A HUGE POTENTIAL PROBLEM
Since the Financial Crisis the US Federal Reserve has increased its balance sheet by approximately $3.5 Trillion. In this same period the Junk Bond (HY) issuers have issued $2.2T of debt which the markets have 'gobbled' up to achieve yield. The question is what happens if they start selling some of that debt to avoid capital losses. This problem is compounded by regulations since the financial crisis which has significantly curtailed banks making markets in these instruments. Many worry that Investment Grade (IG) bonds also issued over the same period will be "infected", especially with a historic $1.3T being sold for the first time in 2015 to significantly fund stock buybacks and dividend payouts. This is a 'witch's brew' for a potential disaster.
CORPORATE LEVERAGE
With Corporate Leverage back to the point at which past default cycles started kicking in, there are more reasons to worry, as corporate cash flow and EBITDA fall while the Federal Reserve raises rates.
Worsening cash flow to debt ratios normally force credit downgrades making credit more expensive and harder to get. This is coming at a time when major Junk Bond issuers in the Energy and Commodity sector are being hardest hit by falling pricing. They are trapped and investors know this and are now worried about junk bond liquidity.
A SLOWING GLOBAL ECONOMY
John and Gord both see a steadily deteriorating global economy which will bring further pressures to an already troubling situtation.
John lays out the torrent of bad news coming as the Fed begins raising rates:
Brazil’s currency sinks after Fitch cuts rating to junk status
The question is whether the Fed will be able to follow through with its stated policy direction.
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WORRY OF CONTAGION
The problems in the Junk Bond market are not isolated to just the hard hit commodity and energy sectors. The protracted period of "easy money" created by Fed policy has sowed its seeds across all economic sectors.
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