"Investors
call time on junk bond bull run - Returns fall as easy money era nears
end" - Financial Times, July 25, 2014
"Blowing
Bubbles at the Federal Reserve" - American Enterprise Institute Ideas,
July 1, 2014
"Could the
Junk Bond Bubble Be About to Burst" - Bloomberg, June 17, 2014
"Reasons
to Fear and Love Junk Bonds" - Forbes, May 8, 2014
"How to
Spot a Market Bubble - Investors can get burned when the air rushes out of a
hot market" - Wall Street Journal, April 18, 2014
"Junk Bond
Returns Can Plunge Before Default Rates Rise" - Barron's, March 11, 2014
If
you type in "high yield bubble 2014" into Google, there are 2,140,000
results. "Junk bond bubble 2014" yields 174,000 results.
"Credit bubble 2014" shows an unwieldy 33,200,000 results.
Don't worry, there will be plenty more headlines to come. In fact,
we have considered that the headlines may be coming sooner than we expected.
The
calls from well-known investors and economists are becoming louder by the day,
yet naysayers continue to try to squeeze out the last few basis points of returns
from high yield bonds. As the end of QE is now in sight, questions are
starting to pop up more often as to how the exit will be handled.
Interest rates will rise soon, for reasons not yet perfectly clear to me.
One reason that I'm fairly confident in that they will not rise for is
that "the economy is firing on all cylinders".
The
equity market, although not excessively overpriced, is long overdue for a
correction. Consider this data since 1929, provided by Ned Davis
Research: Average secular bull markets have 84 trading days between 5%
corrections, average secular bear markets have 31 trading days between 5%
corrections and the current run has had 113 trading days between 5%
corrections. More significantly, average secular bull markets have 331
trading days between 10% corrections, average secular bear markets have 91
trading days between 10% corrections and the current run has had 699 trading
days between 10% corrections. Lastly, and perhaps most alarming, average
secular bull markets have 1105 trading days between 20% corrections, average
secular bear markets have 486 trading days between 20% corrections and the
current run has had 1348 trading days (nearly 5.5 years) between 20%
corrections.
We
are neither alarmists, nor permabears. We know that there are certain
well-respected economists that call for the world to regularly end, and when
there is a significant bubble that burst, they come out of hiding. This
is not us...We were long high yield credit from 2004-2006, we were short high yield
credit from 2007-2008, we were long again from 2009-2011 and we were then long
post-reorg equity from 2011-2013. We have been through the cycle, and
feel that the time is right again. Spreads have widened 44 basis points
this month and high yield is on pace for its worst month in a year.
According to Fed Chairwoman Janet Yellen, valuations for high yield bonds
"appear stretched". Additionally, mutual fund flows are
starting to turn negative ($1.68 B of high yield outflows for the week ended
7/18, including $1.07 B from HY ETFs), GDP growth is still paltry, QE is ending
and interest rates will soon rise.
Whether it is the end of QE, an equity market
correction (large or small), war in the Gaza Strip, civilian planes being shot
out of the sky or just the realization that risk in the high yield market is
not being priced correctly, something will trigger the move in high yield that
we have been preparing for. Forget about the last few basis points of
return, and consider taking advantage of the most obvious trade over the next
few years - short high yield bonds. We think the time is now.
Please
mark your calendars for September 17th at 11:30AM EST for our next
webinar with Dr. Ed Altman on the State of the HY Market. Please reach out to Jeff Trongone for further
details, or to set up a meeting to discuss the opportunity set.
Richard
Travia
Director
of Research
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