Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Intel Empire Fights Back with Rocket and Alder Lake! - 24th Jan 21
4 Reasons for Coronavirus 2021 Hope - 24th Jan 21
Apple M1 Chip Another Nail in Intel's Coffin - Top AI Tech Stocks 2021 - 24th Jan 21
Stock Market: Why You Should Prepare for a Jump in Volatility - 24th Jan 21
What’s next for Bitcoin Price – $56k or $16k? - 24th Jan 21
How Does Credit Repair Work? - 24th Jan 21
Silver Price 2021 Roadmap - 22nd Jan 21
Why Biden Wants to Win the Fight for $15 Federal Minimum Wage - 22nd Jan 21
Here’s Why Gold Recently Moved Up - 22nd Jan 21
US Dollar Decline creates New Sector Opportunities to Trade - 22nd Jan 21
Sandisk Extreme Micro SDXC Memory Card Read Write Speed Test Actual vs Sales Pitch - 22nd Jan 21
NHS Recommends Oximeter Oxygen Sensor Monitors for Everyone 10 Months Late! - 22nd Jan 21
DoorDash Has All the Makings of the “Next Amazon” - 22nd Jan 21
How to Survive a Silver-Gold Sucker Punch - 22nd Jan 21
2021: The Year of the Gripping Hand - 22nd Jan 21
Technology Minerals appoints ex-BP Petrochemicals CEO as Advisor - 22nd Jan 21
Gold Price Drops Amid Stimulus and Poor Data - 21st Jan 21
Protecting the Vulnerable 2021 - 21st Jan 21
How To Play The Next Stage Of The Marijuana Boom - 21st Jan 21
UK Schools Lockdown 2021 Covid Education Crisis - Home Learning Routine - 21st Jan 21
General Artificial Intelligence Was BORN in 2020! GPT-3, Deep Mind - 20th Jan 21
Bitcoin Price Crash: FCA Warning Was a Slap in the Face. But Not the Cause - 20th Jan 21
US Coronavirus Pandemic 2021 - We’re Going to Need More Than a Vaccine - 20th Jan 21
The Biggest Biotech Story Of 2021? - 20th Jan 21
Biden Bailout, Democrat Takeover to Drive Americans into Gold - 20th Jan 21
Pandemic 2020 Is Gone! Will 2021 Be Better for Gold? - 20th Jan 21
Trump and Coronavirus Pandemic Final US Catastrophe 2021 - 19th Jan 21
How To Find Market Momentum Trades for Explosive Gains - 19th Jan 21
Cryptos: 5 Simple Strategies to Catch the Next Opportunity - 19th Jan 21
Who Will NEXT Be Removed from the Internet? - 19th Jan 21
This Small Company Could Revolutionize The Trillion-Dollar Drug Sector - 19th Jan 21
Gold/SPX Ratio and the Gold Stock Case - 18th Jan 21
More Stock Market Speculative Signs, Energy Rebound, Commodities Breakout - 18th Jan 21
Higher Yields Hit Gold Price, But for How Long? - 18th Jan 21
Some Basic Facts About Forex Trading - 18th Jan 21
Custom Build PC 2021 - Ryzen 5950x, RTX 3080, 64gb DDR4 Specs - Scan Computers 3SX Order Day 11 - 17th Jan 21
UK Car MOT Covid-19 Lockdown Extension 2021 - 17th Jan 21
Why Nvidia Is My “Slam Dunk” Stock Investment for the Decade - 16th Jan 21
Three Financial Markets Price Drivers in a Globalized World - 16th Jan 21
Sheffield Turns Coronavirus Tide, Covid-19 Infections Half Rest of England, implies Fast Pandemic Recovery - 16th Jan 21
Covid and Democrat Blue Wave Beats Gold - 15th Jan 21
On Regime Change, Reputations, the Markets, and Gold and Silver - 15th Jan 21
US Coronavirus Pandemic Final Catastrophe 2021 - 15th Jan 21
The World’s Next Great Onshore Oil Discovery Could Be Here - 15th Jan 21
UK Coronavirus Final Pandemic Catastrophe 2021 - 14th Jan 21
Here's Why Blind Contrarianism Investing Failed in 2020 - 14th Jan 21
US Yield Curve Relentlessly Steepens, Whilst Gold Price Builds a Handle - 14th Jan 21
NEW UK MOT Extensions or has my Car Plate Been Cloned? - 14th Jan 21
How to Save Money While Decorating Your First House - 14th Jan 21
Car Number Plate Cloned Detective Work - PY16 JXV - 14th Jan 21
Big Oil Missed This, Now It Could Be Worth Billions - 14th Jan 21
Are you a Forex trader who needs a bank account? We have the solution! - 14th Jan 21
Finetero Review – Accurate and Efficient Stock Trading Services? - 14th Jan 21

Market Oracle FREE Newsletter

FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Retirees Are Risking Their Life Savings on Junk Bonds

Interest-Rates / Pensions & Retirement Jul 29, 2016 - 01:58 PM GMT

By: John_Mauldin

Interest-Rates

Retirees and other investors are reaching farther and farther for yield. They’re piling into all sorts of increasingly risky investments. So, it should come as no surprise that credit spreads are shrinking between what in theory are risk-free investments and other investments.

My friend Danielle DiMartino Booth, formerly at the Dallas Fed, covers a range of topics affected by central-bank policies. I think she is going to be an increasingly visible force in the world of central bank critics.


Danielle deals with credit spreads—specifically high-yield bonds—in the article below. She urges, “This is important folks, your sweet grandparents could well own junk bonds in their desperate need to generate yield on their atrophying retirement funds!”

It’s not a long piece, and it’s easy reading, even if it won’t make you comfortable.

The Bond Market: Beware of Junkyard Dogs

By Danielle DiMartino Booth

Having spent a chunk of his youth “shopping” them, Jim Croce came to know a thing or two about junkyards. In those youthful days, should his clunker de jour be missing some vital part or parts, a trolling expedition through South Philly’s scrap heaps was always the enterprising Croce’s preferred method of procurement.

Amid all of Croce’s parts foraging, it was a universal joint for a ‘57 Chevy and a ‘51 Dodge transmission, two must have and must-be-cheap or, better yet, free, parts that the legendary folk singer still recalled. He also reminisced that junkyards could and would provide a no frills, but highly motivated and easy way to get in some cardio, as in running for your life.

“I got to know many junkyards well, and they all have dogs in them,” the late Croce said in a 1973 interview. “They all have either an axle tied around their necks or an old lawnmower to keep ‘em at least slowed down a bit, so you have a decent chance of getting away from them.”

So was born the junkyard dog yardstick by which to measure the meanness of one Bad, Bad Leroy Brown, Croce’s hit which landed at the top of the charts 42 years ago this week.

As for high yield bond analysts, they aren’t exactly known for catchy turns of phrase. However, in recent weeks, they’ve shed the dry and donned the dramatic, as you’ll soon see. Such is the overheated state of the junk bond market this sweltering summer.

In his latest missive, Deutsche Bank’s Oleg Melentyev, arguably the best-in-class high yield analyst among his sell-side peers, warned of the perils of investing in this “frenzied market.”

Legendary high yield investor Marty Fridson shares Melentyev’s concerns and has for some time. By his best estimate, high yield was already in “extreme overvaluation” territory on June 30th, defined as being one standard deviation above fair value. Flash forward two weeks, and he calculates that the standard deviation has doubled.

(A quick Statistics 101 refresher: standard deviation tells you how tightly clustered or wide-of-the-center individual components of a given data set are from their mean. Remember the grade bell curve the engineering undergrads blew in business school? When all of the test scores came in on top of each other, the bell curve was super steep; when there was vast divergence, the bell curve was low and wide.)

Defining bond valuation also requires one employ “spreads,” which compare the prevailing yields on a given credit to a supposedly risk-free Treasury of a comparable maturity. And that means you have to get down to the nitty-gritty of measuring risk in basis points (bps), or hundredths of a percentage point.

In the event your eyes have rolled into the back of your head, listen up! This is important folks, your sweet grandparents could well own junk bonds in their desperate need to generate yield on their atrophying retirement funds!

With that preamble posited, on July 15th the option-adjusted spread on Bank of America Merrill Lynch’s High Yield Index was 542 basis points. That compares to 621 bps on June 30th. The lower the spread, the less extra compensation investors are demanding for taking on the added risk of being exposed to, well, junky bonds.

Of the compression in spreads, an incredulous Fridson could only characterize the overvaluation which begat more overvaluation as, “more staggering.”

Now in light of this, just how did mom & pop investors react to the price increase? Well how else? They poured $4.4 billion into high yield mutual funds, the second highest weekly inflow on record after March 2nd’s $5.3 billion inflow.

Bloomberg caught up with yet another stunned strategist:  “They’re out there scrounging through the dumpster looking for yield,” worried Karyn Cavanaugh of Voya Capital Management. “When you have artificially low rates, you force people to go out and look for things they normally wouldn’t.”

The question is, will investor insouciance ever come back to haunt them? They, as in investors, certainly don’t seem to think so.

The Daily Shot is a must-read email proffering just about every graph that’s important for investors in one succinct one-stop shop, and it’s free. The Shot’s editor, the estimable Dr. Lev Borodovsky, is notoriously judicious with his editorial additives. So when he adds a quip, his readers understandably sit up and take note.

In Tuesday’s Shot, Borodovsky featured a graph of the VIX Index, the so-called ‘fear gauge,’ which depicts the perceived risk of owning stocks, which have traditionally moved in lockstep with junk bonds. Reflecting extreme complacency, the VIX is sitting at the lowest level since last August. “In the equity markets,” Borodovsky recapped, “the VIX hits a multi-month low. All is well.”

Or not. The Shot goes on to depict the price-to-earnings ratio on the S&P 500 at the highest level since at least 2006. “These valuations rely on extremely low long-term rates,” Borodovsky cautioned.

As a punctuation mark, as in exclamation, Borodovsky features two charts on the high yield market. At the risk of over-paraphrasing, the high yield market is apparently no longer concerned about energy prices, which have yet to stage the oft-predicted blistering rebound. How so?

Despite the defaults that continue to emanate from the oil patch, the performance of high yield bonds has completely divorced itself from that of still-depressed crude prices. The mirror image of this nonchalance is that investors are no longer demanding a premium level of compensation for owning high yield energy issuers vis-à-vis their non-energy brethren.

In priceless understatement, Borodovsky concludes that, “High yield is definitely starting to look frothy.”

As for Deutsche’s Melentyev, he isn’t bothering to wait for the ink to dry on the clear message written on the wall. In his latest note to clients, he ratchets up his expectations for HY (high yield) defaults to rise this year beyond his worst case initial scenario – and it ain’t just an energy story.

“At this point, we have little doubt that our original forecast of a 4% ex-commodity HY default rate will be met by late 2016/early 2017. Moreover, we think there are now enough reasons to believe that defaults could rise to 5%, ex-commodities, sometime over the next year or so. Coupled with our 20% commodity HY default rate forecast, we are looking at 7.25% aggregate default rate sometime around mid-2017.”

In the event you’ve fallen off Planet Earth in recent weeks, the global corporate default count, as in companies reneging on their promises to make good on those coupon payments, is at the highest level since 2009. And if your memory’s eye has erased 2009 to prevent permanent scarring, the economy was in a full meltdown state back then.

Let’s get this straight. Defaults are going through the roof and investors are flocking to the sector in record numbers? And how.

Moody’s Tiina Siilaberg keeps an eagle’s eye on the concessions investors give to issuers in the form of protections they don’t demand. They’re called ‘covenants,’ which Investopedia defines as, “designed to protect the interests of both parties. Restrictive covenants forbid the issuer from undertaking certain activities; positive covenants require the issuer to meet specific requirements.”

By Siilaberg’s latest tally, covenant protections are at their weakest level in recorded history. To translate, investors’ collective interests are as vulnerable as they’ve ever been. Though the leveraged loan market remains open for business, Siilaberg is apprehensive about what’s just over the horizon given stretched valuations.

“Issuance in the high yield bond market is still relatively weak compared to historic levels,” Siilaberg said. “I worry, though, because refinancing risk for many lower-rated issuers is close to an all-time high.”

The culprit? That would be a delusional reliance on what Melentyev refers to as, “the new narrative,” and “its apparent reliance on (a) strong monetary response.” Unconventional monetary policy is delivering, “little tangible benefit.”

Overreaching central bankers are in fact doing more harm than good at this juncture. Though small investors may not be wise to the damage being wrought, veterans of financial market warfare are weary to the point of exhaustion.

The endless waiting for Godot has apparently worn their resolve down to near nothing…with good reason. For all of central bankers’ Herculean efforts, expectations that U.S. job losses will accelerate are at a two-year high while households’ prospects for the economy over the next year have fallen to a two-year low.

Pride will surely precede the fall of the orthodoxy of today’s accepted monetary policy framework. But at what cost?

“Everyone in the world needs yield and nothing else matters,” Melentyev laments. “This has never ended in any sort of a problem before, so we can all go back to sleep.” And what happens when we’re abruptly shaken from our slumber?

Recognizing the painfully obvious, Voya’s Cavanaugh observed, “This isn’t a really normal environment.”

Thank you Chair Yellen & Co. for rendering snarling, lawn mower toting junk bond dogs cute and cuddly critters to retirees on fixed incomes.

Subscribe to John Mauldin’s Free Weekly Publication

Each week in Outside the Box, John Mauldin highlights a thoughtful, provocative essay from a fellow analyst or economic expert. Some will inspire you. Some will make you uncomfortable. All will challenge you to think outside the box. Subscribe now!

John Mauldin Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules