Thursday, June 6, 2013
It's not hard to spot the *new* "subprime" of this current monetary bubble cycle i.e. the epicenter for the next collapse. Aside from Japanese (Spanish, Italian, "insert country here") bonds, the most likely next candidate is junk (aka. high yield) bonds.
As we recall from 2008, the epicenter of that meltdown revolved around "subprime" mortgages i.e. mortgages given to people with low/no credit ratings. It was the inevitable consequence of 1% Fed policy (post 9/11), the ensuing housing boom, low lending standards - all mixed together for four years until it all blew up, highly predictably, although the vast majority were taken by surprise.
Similarly today, in addition to the massive amounts of sovereign debt that has been issued in the past four years, there has been massive amounts of "high yield" junk bond corporate issuance, as corporate treasurers take advantage of record low interest rates. 2012 was a record year for the volume of junk bond issuance, and yet here 5 months into 2013, junk bond issuance is already 53% higher than it was during last year's record run ! Meanwhile, junk bond yields which are inversely correlated to junk bond prices, hit a record low in early May - and have been rising ever since aka. higher interest rates.
This should come as no surprise, since junk bonds, unlike regular corporate bonds, carry high default risk and therefore they are highly correlated to the stock market. The big difference between junk bonds and stocks however, is that junk bonds need to be "rolled over" and refinanced periodically, so if prices fall (interest rates rise) as they are now, then these companies will be unable to refinance their existing debt loads - aka. bankrupt. Sound familiar?
Below we see (far right) that high yield bonds (HYG ETF) have already given up a year's worth of yield in the past month due to the fall in prices. Far left shows what happened in 2008 to junk bond prices. Meanwhile, look at volume currently. Once again, Fed policy boosted prices and lowered interest rates, leading to a deluge of supply. Meanwhile, the low interest rates (yields) is killing demand. Not a healthy market dynamic to have unprecedented supply (issuance) meeting up with falling demand (outflows), so this is the market to watch:
Posted by Mac10 at 5:39 AM