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In the world of finance you never really know what will start a correction or a crash. But what you can do is watch for warning signs.
Right now there are a number of flash points in the world, from warnings of a slowdown in the Chinese economy, to Russia’s imperialistic moves in Ukraine. And of course, there’s always the Fed’s $3 trillion balance sheet. With analysts warning that the Fed’s QE bond purchases have created imbalances and bubbles in the economy due to ultra-low interest rates.
Many commentators also say that low interest rates have created a bubble in housing, emerging markets, and as of yesterday, tech stocks. But according to Briton Ryle who runs The Wealth Advisory income and dividend portfolio:
“Upon further investigation those bubble claims tend to deflate when you check the numbers. The trailing P/E for the S&P 500 is 18. Housing prices are well below peak levels, even with low interest rates. And with the exception of Wells Fargo (NYSE: WFC), banks have lowered their reliance on mortgage income.”
If you want to find the source of a crash or a correction, look for a place or sector where cash flow could change very quickly. Says Ryle.
Where is that place? The corporate bond market — especially the junk bond market.
Corporate America is bingeing on debt. In 2012 and 2013, companies borrowed something like $2.5 trillion dollars. With around $600 billion of that high-yield bonds. For comparison’s sake, just $43 billion in junk bonds were issued in 2008.
So what’s the risk? In 2013, the default rate for junk bonds was just 2.4%. On average, the default rate for junk bonds is 4.8%. A return to that level would mean $30 billion in losses on bonds issued in the last two years. But the actual risk of junk bonds could be much much worse…
There will be a reckoning for the corporate bond market. It’s inevitable that bond defaults will rise, some companies will fail, and bondholders will lose money.
If you own any “high-yield” bond funds, you should consider getting out. Sure, they’ve averaged something like 17% a year for the last couple of years, but that ends as interest rates go higher.
Todays Other Top Stories
Louisville Business First : – The municipal bond market is back. – The municipal bond market is back, and if public projects are going to continue, investors need to snap up munis.
Wealth Management: – How bad is your tax day hangover? – Here is a sobering fact: Investors in the highest tax bracket gave roughly half of their taxable bond investment income to Uncle Sam in the 2013 tax year. By contrast, the 2013 tax rate for tax-exempt municipal bonds (munis) is far more manageable at 0%.
Finance Well: – Municipal bond insurance: What to consider before investing. – Two recent upgrades to the ratings of large municipal bond insurers highlight how much the landscape for insured municipal bonds has changed since the financial crisis of 2008. Since then, the number of municipal bond insurers has declined and their credit ratings have fallen. The share of the newly issued munis covered by bond insurance has also shrunk dramatically. That’s caused many municipal market participants to question the value of insurance.
Charles Schwab: – Municipal bonds: Leading the fixed income pack. – Municipal bonds had their best quarter since the 3rd quarter of 2011 due to falling Treasury yields and limited supply.
Bloomberg: – April shows biggest high-yield ETF gets most money. – Investors seeking higher yields as the economy grows are making a winner of the biggest exchange-traded fund that tracks the municipal market’s riskiest securities.
LearnBonds: – Debentures – Features, types and benefits. – Debentures are a type of debt instrument that are not secured by specific property or collateral, but are backed by the full faith and credit of the issuer. If the issuer were to liquidate, the debenture holder is considered a general creditor, and has a claim on any assets not specifically pledged to secure other debt. Debentures are frequently issued by large corporations and governments to raise capital.
Acting Man: – T-Bonds Are Universally Hated, Not a Single Economist Expects an Economic Downturn. – Jim Bianco points out in a recent market comment that the 67 economists taking part in a regular Bloomberg survey have a unanimous forecast regarding treasury bond yields: they will be higher 6 months from now. This is a truly striking result, and given the well-known propensity of mainstream economists to guess wrong (their forecasts largely consist of extrapolating the most recent short term trend), it may provide us with a few insights.
WSJ: – Treasury bonds pare losses on Ukraine concerns. – Treasury bonds clawed back most of their price declines Thursday as the latest signs of growing tensions between Russia and Ukraine boosted demand for haven bonds.
Donald van Deventer: – AT&T Inc.: Bond market implications for the dividend yield. – We believe a majority of analysts would rate AT&T Inc. as investment grade, but long run default probabilities are rising steadily.
Zacks: – Forget Treasury bonds, try this top corporate bond ETF instead. – Thanks to rock-bottom interest rate of government backed bonds which offer safe haven opportunities, the U.S. corporate bond market has been on a rocky path as these normally yield higher than their Fed cousins. Also, a slow-but-steady U.S. market recovery and strengthening of corporate America have helped the related high yield bond market to climb.
BusinessDay: – ‘Yellen effect’ still holding for emerging markets. – It seems that what I refer to as the ‘Yellen effect’ is still making investors happy enough to continue holding emerging-market assets and investing in safe havens such as gold.
WSJ: – Investors embrace ‘catastrophe bonds’. – Insurance companies are taking advantage of the appetite for high-yielding debt by selling bonds that can force investors to help pay for the cost.
Market Realist: – Why are investors less and less attracted to bonds? – The bond market was spared a hard landing due to the volatile external environment and subdued indicators due to extreme weather conditions during the early part of the year. All that is changing now.
AllianceBernstein: – Go global to hedge against rising rates. – Did you know that a global bond strategy may reduce direct exposure to U.S. rates.
Forbes: – How to manage maturity risk in bond funds as the Fed pulls back. – A more strategic approach to avoid the headache of reactionary allocation changes in a declining market is the use of Maturity Bond Funds.
ETF Report: – Daily ETF watch: Bond, MLP ETFs launching. – iShares is launching today a bond fund of funds that includes government and corporate debt, while Barclays is bringing to market a new MLP strategy in an ETN wrapper—two strategies that should cater to income-hungry investors.
HedgeCo.net: – Hedge funds investors return to the bond market, just not to PIMCO. – Liquid alternative mutual funds continue to be the fastest growing segment of the open-end mutual fund industry based on asset flows through March 31, 2014, as reported by Morningstar in their monthly Morningstar Direct U.S. Open-End Asset Flows Update.
Bloomberg: – Choosing ‘all of the above’ in your income ETF. – As interest rates play a little game of limbo with us, the challenge to income investors is growing. Plain-vanilla investments with decent yields are increasingly hard to come by.
Kiesel Dep CIO: America’s top building material companies & homebuilders generating 10% y/y gains in pricing. Own companies w pricing power
— PIMCO (@PIMCO) April 24, 2014
#Illinois GO prelim pricing out: 5s of 2024 yield 3.33%, or +101 to MMA 5% AAA Benchmark, two weeks ago spread was +97 in competitive deal
— Muni Market Advisors (@Muni_Mkt_Advis) April 24, 2014
pretty close to the current 5yr UST nominal rate
— Bob Brinker (@BobBrinker) April 24, 2014