Junk Bond 'Bubble' Defies State of Credit Expansion

Junk bonds are the next “bubble

Since March, credit spreads on the most speculative debt have crashed to their lowest levels since the Lehman Brothers bankruptcy in mid-September.

High-yield or junk bonds now yield 12.60% compared to a post-Lehman Brothers bankruptcy high of 22.49% in October. Since the stock market lows on March 9th, junk prices have skyrocketed more than 55%, vastly outstripping the 32% gain in the S&P 500.

That rally makes junk bonds best-performing segment of credit in 2009, on the heels of a 25% crash last year. That easily outpaces the fixed-income competition.

Investors continue to underestimate the risks lured by fat yields and the historical crash in 2008. High-yield mutual fund inflows are also ballooning again since April as investors shove billions into below investment grade bond funds.

Unfortunately, it’s likely only the shrewd or lucky ones will sell into current market strength. Most junk bond investors will hang onto their mutual funds and eventually get cleaned out when the next bear market ravages this sector.

Junk Bond Rally Defies Common Sense; Poised to Crash

This party is probably home to the next crash in global markets.

Yes, credit markets have already collapsed since late 2007-2008; but the junk bond market has no business trading at these absurd levels. Not when they’re facing rising defaults over the next 12-18 months, and cornered by an environment of tight credit in the United States and Europe.

Unlike previous economic recessions, when riskier assets like junk bonds offered smart calculated speculations, this cycle is unlike anything we’ve seen since the 1930s.

And there’s just no getting around the fact that they need to raise about $950 billion dollars to meet their obligations over the next five years. That’s an unprecedented financing hurdle.

Just how in the world junk bond issuers will raise all of this money in an ongoing environment of bank cash-hoarding and a reluctance to lend…that’s anyone’s guess. I think it’s safe to forecast that many of these companies won’t be able to secure credit or revolving credit because banks simply aren’t expanding loan portfolios – especially not to below-investment-grade credits like junk bonds.

If you believe, like I do, that junk bonds are heading into the disaster zone amid a tight credit noose still afflicting below investment grade companies…then consider shorting or betting against the sector.

Comments

[BGRT:]

You're comparing current junk yields to when there was absolute fear in the markets. Institutions were dumping risky assets on a daily basis, leading to these yields that were overly pessimistic. Additionally, even with 12.6% yield and an average coupon of 8%, you're talking about junk bonds trading at an average of 63% of face value. Senior secured debt holders should get more than that in case of a bankruptcy. It's still not that bad of a time to buy junk debt, although it certainly wasn't as attractive as in March.

Jul 23 03:33 AM

[Jade Bond:]

One word: "Recovery".
Granted, the industrial capitalist market in America might be over in 2 years. On the other hand, probably not.

Yes, this is unlike anything since 1930. When has the United States Central Bank ever been a market maker in junk bonds?

Personally, I consider this more like a once-in-a-lifetime opportunity. Well, actually, twice now. Look at the opportunity in bonds back in the '80s when me and all the other hard money advocates were warning the human race that U.S. deficits were going to ruin the dollar, collapse the U.S. economy, and make paupers and pawns out of all of us. In fact, you can still get the book on Amazon, first published in 1982!!
www.amazon.com/s/ref=n...

If you're in the doom-and-gloom camp, I highly recommend this book. It contains great practical insights into protecting your assets in a decaying financial world where the poor and unemployed demand economic fairness and equality.

I'm ready for the worsts, but I'll make a killing if history repeats itself. I mean 18th and 19th century history, not 3rd and 4th.

Jul 23 11:33 AM

[GaryR:]

The sky is falling! The sky is falling!
I still cant believe that after the last 4 months there are people out there still calling for the END OF LIFE AS WE KNOW IT
Get over yourselves, suck it up, admit that you were and are still wrong and get with the program before you miss the next cycle too.
As of TODAY, we just completed the first complete "cycle crosover"
of prices and MA's since the bottom, and yes, that was the bottom...
I bought my first equity investments EVER on March 12 (junk bond funds) and the Cap gains and divis are Sweet!
You already missed the bottom, so dont miss the rest!
Check a Daily chart profile for SPY since april and look at it in contrast (mountain view) .or just squint at the drawn outline...
You will see my friend Mr Market, who dresses like Batman, is very muscular and is giving you non-believers and short sellers a
double "up yours" salute..
Its a thing of beauty and I just cant figure out how the market manipulators were able to pull off that profile!
If you really want to wait, I'll be glad to sell you my shares when you get in at the top
Good luck!

Jul 23 09:38 PM

[GaryR:]

Yea, Check my April 15 comments too.. nothings changed,Im still right and you are losers...

Jul 23 09:43 PM

[Brian L.:]

I own High Yield Bond Funds. The yield when I bought it was 9%. If the fund goes higher then I can cash out and make a nice 12% or higher return in possibly 3-4 months. If it goes lower. I can invest more and still gain 9% or better yield. I cant follow this article. A person that invests when the fund goes lower... I ask how is taking yields that are decent bad. I need some light shed on this. I see the yield going down. Im not investing more. But the rate of return on the price per share is going up.

Jul 24 12:16 AM

[doctordoctor:]

if credit gets tighter, and funds for junk decline, wont junk rates go up? back in 1979-82 period, junk rates were over 24% per annum!! mm rates were above 18%, and still there was unmet demand for credit. history tells us current junk rates are about average. so just dont see how the author arrived at his conclusions unless he really really believes "this time its different."

Jul 26 03:51 PM