Worsening Risk/Reward Fundamentals In US Corporate Credit
Sober Look | Jun 08, 2014 02:25AM ET
US corporate credit markets, particularly high yield bonds, are becoming quite frothy, as risk/reward dynamics continue to worsen. Here are some key indicators:
1. In the last couple of years high yield supply has been massive relative to equities. HY has had no shortage of buyers thus far, but the market is becoming increasingly comfortable with the primary market buyers always being there. Investors are ignoring the fact that such demand may not always be the there.
2. High yield bond spreads have declined to new post-recession lows, with the latest spread tightening driven by yesterday's ECB's easing. Bond holders are simply not being compensated for the risk they take.
3. Similarly, corporate credit default swap spreads are falling as well. Here is what CDX (index of CDS) spreads have done recently for both investment grade and HY indices.
4. Valuations in the most leveraged and lower quality portion of the credit spectrum have risen dramatically. Over 60% of corporate bonds rated CCC by Fitch now trade above par.
Get The News You Want
To be sure, improving economic fundamentals in the US have reduced default risks considerably. But we are now back to the days when the ability to refinance is taken for granted and current cash flow to service debt is starting to become less relevant. With banks' ability to hold inventory impaired, these markets are becoming quite vulnerable to a sharp correction.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.