Bernard Thomas

Bernard Thomas
Contributor since: 2009
Company: Bond Squad
Bravo. I have written very similar sentiments in my Bond Squad reports. In today's report I wrote:
The marketing spiel which stated that high-risk assets are performing well because of Fed policy and will continue rising when the economy pick up displays a clear misunderstanding of the risk asset markets.
There are no upward pressures on rates. Thanks to disnflation/deflation overseas and the strong dollar pushing down energy prices, headline inflation could trend lower in the U.S.
Banks have much excess reserves, but it really isn't excess when you consider that capital requirements keep rising and banks are very selective when lending so as not to gave the GSEs put mortgages back to the bank.
The demand for credit is poor, but much of this is longer-term and structural in nature. Investors and market participants waiting for lending to pick up might as well join Linus in waiting for the great pumpkin.
The economy you see is the economy you get until fiscal polices become more pro-growth, both here and abroad. Demographics and tastes have changed. So must fiscal policies.
What most economists and investors did not foresee was global disinflation and a U.S. economy that, while a little bit better, is still just cruising along. We at b
Bond Squad ( also believed the 10-year would end the year in the mid-3.00% area, we had a sneaking suspicion that we could see rates dip into the 2s before marching higher. Now te economy looks a little softer and Fed policy has become less inflationary while economic growth has settled in to a nice, but not robust pace. Demographics and a very slack global labor market (one which has not shot at becoming right enough to generate significant wage pressures in the foreseeable future) threaten (promise) to keep rates low. The 10-year could peak in the mid 3s in the next rising cycle. The Fed Funds Rate might not get beyond 3.00% as growth and inflation might not be strong enough to push the Fed to act aggressively and the Fed has other tools (repos, deposit rate) with which it can tighten.
My fear is with risk assets, even a modest rise in short-term rates without stronger revenue growth could kill junk debt, even the much-loved floating rate loans.
The Great Asset Allocation Renormalization is under way. The demand for quality income-producing instruments with predictable cash flows and stated maturities will continue to increase during the next decade.
The reason why we should care is that retail investors are buying "senior bank loans" which are senior obligations of shaky companies and not issued by banks using questionable lending standards and weak covenants. Many investors thing they are buying high-quality investments and are unaware that the loans can be rated B, CCC or not rated at all.
Senior bank loans are not as "fool-proof" as wholesalers portend (pretend). They are senior claims on risky credits. They might be safer than CCC-rated bonds, but they are in now way a conservative or moderate risk investment. As more and more loans are cov-lite, the corporate borrower is able to "behave badly" with little recourse from borrowers.
The "interest-protection" aspect is unneeded insurance at this time. Why? Bank loans usually float off of Libor, usually three-month Libor. Except in times of crisis, three month Libor move with Fed Funds rates. What investors are probably looking at is three more years with no coupon increase. When coupons do rise, they will do so gradually and modestly. If rates rise more rapidly, businesses might find that they are unable to pay the higher interest rate and/or they can no longer obtain affordable financing as attractive returns are now available in higher-quality investments. This would be especially true if the yield curve steepened. At that point, risky corporate borrowers find find it beneficial to restructure its debt while giving investors less than 100 cents on the dollar. Investors should not assume that they will receive rising income streams or even 100 cents on the dollar at maturity. Bank loans are speculative investments, period.
I like 5 to ten year bank bonds. Spreads are wider enough that there should be some more spraad compression as rates rise compression, which should offset some of the rate rise.
Correct!!! This is how play HY. Use common sense, don't extend out too far and stay in HY, not junk. There is a difference.
Back to 2008. Yeah that is a long time. 2009 to now has been the golden age for HY! Remember the junk bond scandals of the late 80s / early 90s when companies defaulted left and right. Please, have a little deeper perspective. I have been in the bond market for more than two decades.
Why don't we just use default rate data for mortages during the housing bubble (when they were at all-time lows) and use that as the norm too. Hence BUBBLE!
Hmm, for a company to call a pfd, it usually needs to save at least .75 on the coupon (cost of financing) to cover costs of coming to market and realizing a meaningful savings. Do you really think that preferreds which have been issued in the current low-rate environment will ever be able to be called?
This is why I say my grandchildren will be trading some of these 50-year or perpetual preferreds. Preferreds are negatively convexed and call features are designed always benefit the issuer. It gives them the right to call when they can refinance at lower rates, but they can leave them out there when rates rise and enjoy realtively cheap financing.
10-year BBB and A-rated bonds give you better returns when duration and seniority are considered. Preferreds are long-term securities which are called when beneficial for the issuer, as as been the case for the past 30 years.
How will the investor feel holding a 5.75% pfd valued at $19 when new preferreds are being issued at 8.00% and 10-year corporatre seniro debt is being issued at 6.50%?
The situation is this. There is much money in HY that would not be there if rates were normal and attractive yields could be had in investment grade bonds. There is also money in HY from equities. When the economy and rates "normalize, capital shoudl return to their traditional homes. Many curent BBB-rated invetsors wil move to A. Some BB investors will move to BBB, B to BB and CCC to B. Itis at the very bottom of the scale where the pain will be concentrated.
HY bonds do behave more like stocks, but they are financing sources for corporate issuers with weak credits. They are subject to inetrest rates. If the 10-year Treasury is at 4.00% and A-rated indutrials are at 5.00%, BBB-rated at 5.50%, BB ratd at 6.00%, B-rated at 8.50% then CCC might be at 10.00% or more. Some companies may be un willing to refinance at 10.00% and could defualt or restructure debt at less than par.
HY has done well because of low rates. There could be an equal and opposite reaction when the rate situation reverses. HY fund wholesalers and marketers (most of whom do not understand HY bonds and are simply regurgitating what they have been told) are painting a scenario that HY bonds do well when the economy is bad and even better when it is good. If that was the case, they would not be very risky, would they.
HY isusers especially low B, CCC and lower, are very sensitive to financing costs. Many would have already defualted if not for the current rate environment. Wholesalers love HY. Traders are concerned that this is the golden age and it will come to an end within five years. If you are playing with HY, stay five-years (maybe three-years) and less.
If you would like, I can send you a free trial sucbcription to my service "Bond Squad." We don't ask for credit card info for free trials, it is truly free and with no obligation whatsoever.
Higher rates might force elected officials to act, but if they did not the results could be catastrophic for the economy. Put yourself in Bernanke's shoes. He has the economy barely breathing on its own. He has fiscal headwinds from a dysfunctional budget deficit coming next year (not to mention slower global growth. He has a Congress which can't agree on the color of the sky, never mind fiscal policy. Hew will keep policy accommodative, but not necessarily unchaged, until the boys and girls on Capitol Hill can work together on a solution.
muoio; ever hear of comparative advnatage?
Tariffs and protectionism are counter productive in the long run. We cannot become economic Luddites. Speaking if Luddites, reversing the trend of increased automation and efficiency will not work either.
Why will no one admit that for 20 years we lived an unsustainable lifestyle in the U.S. and we need wages and asset prices to reset to be globally competitive?
Strat, not all companies can take advantage of all breaks. Lower the tax rate and eliminate loopholes and everyone benefits. Same goes for personal income tax. Flat tax is best.
Dialectual, I am not paid for these articles.
Problem with bond funds is that they don't necessarily work for income investors. Bonds are bought and sold leading to unintended consequences for income-oriented investors.
ETFs permit equity-like speculation in the fixed income markets. Not good for income-oriented investors.
The entire market recovery, since 2009, has been dollar related, either directly or indirectly (optimism for increased exports).
Cash flow will not decline to default levels, at least ot among the large banks. That is pure hype. Large banks will use their huge cash positions (not simply liquidity, but actual cash) to get through this. Revenues will be down. They will never return to the thrilling days of the early 2000s, but they will be profitable, albeit less so and more conservative in their business models. Regional banks could go belly-up. Housing will be impaired until prices decline significantly further. U.S. growth will average around 2.0% for the next decade and unemp;oyment may not drop below 7% (maybe 8%) in that time.
Overseas jobs can come back if our cost of manufacturing is permitted to fall to where we have a comparative advantage. Of course that would result in deflation and further drops in housing prices. Prices of homes went up too far too fast and should be allowed to correct. We have literally been living on borrowed time.
You are forgetting that the securitization of loans is necesary for banks to lend, especially to those with less-than-stellar credit. Much of that market was fueled by the ability to sell packages of loans at relatively low yields to conservative investors due to the bonds having AAA ratings. Those days are gone. Ratings agencies will not grant AAA ratings so easily and investors are not so eager to buy such securities now that they know what they really are.
Turn the QE up to ludicrous speed.
Great comments guys. Nice to see that people get it.
Good comments all. Gary Shilling may be right again.
You all are correct. The people you mention can't or won't buy a home, should not.
My titles are usually better, but the Seeking Alpha editors change them to their liking.
Good one!!
No kidding. That is trading.
The French economy is a disaster. It is nearly impossible for young people, even college graduates, to find gainful employment. This was true even before the recession. Looking to France as a social and economic model of efficiency is like looking at the New Jersey Nets as a model of basketball prowess.
Correct and we have overhanging housing and have become accustomed to an economy functioning at levels that can be maintained by more leverage for everyone. Good luck with that happening.
I have owned SIRI for 4 years and although I think the company has great potential, it has executed poorly. Customer service is not existent. The separation of the Sirius and XM packages is stupid and the limited choices and inconsistent programing on the sports and news channels on line is annoying. Besides being a shareholder, I also subscribe to Sirius via my truck, my wife's car and via my online subscription. I am strongly considering not renewing. I am not alone.
We will see a long slog up because of replacement. Consumers have to replace worn clothing, appliances, vehicles, etc. However, they will not make unnecessary purchases. Other than that consumptions biggest booster may be a rising population.
Equity market geeks believe that all policies and regulations should be biased to push stock prices higher. They don't care if economic fundamentals support valuations, just stimulate, stimulate, stimulate. Oh yeah, ban those with contrary opinions as they may push markets lower. The U.S. economy was is various states of stimulus almost constantly from 1982 to 2006. We were high (as in drugs), now comes the withdrawal.
I am for mark to market. An asset is only worth what someone is willing to pay for it. Know what? Most toxic assets will never be worth 100 cents on the dollar. They are bad loans written on overvalued properties. Deal with it.