Bonds: Total Market
(New York)
One of the biggest arguments of the junk bond market is this: one needs to be careful of junk bond indexes because they automatically skew investors to the companies with the most debt, making portfolios inherently more risky. The argument has a seemingly sound logic which is similar to the “skew” often referred to in equity ETFs. However, the reality is the complete opposite, as the companies with the most debt actually tend to be larger and have more conservative levels of leverage. The larger companies with the highest total debt in the high yield market tend to have lower default rates, so there is actually no correlative relationship between more debt and higher risk. The analysis is from S&P Global Market Intelligence.
FINSUM: This is very useful analysis, because the more debt = more risk fallacy is an easy-to-fall-into mental trap.
(New York)
Many investors are worried about rising yields, which could wreak havoc on everything from the economy, to income stocks, to all manner of bonds. Well, for what it is worth, Morgan Stanley has just put out a piece arguing that the 3.12% yield seen on the ten-year Treasury recently is it, the peak. Morgan Stanley says that yields will stop rising and they are advising clients to go long Treasury bonds at current yields. The argument stands in contrast to Pimco and JP Morgan, who both see yields moving towards 4%. The one caveat to the call is if trade tensions get settled quickly, as turmoil on that front is one of the bullish drivers they see for Treasuries.
FINSUM: If trade tensions keep flaring we agree that Treasury yields are likely to stay flat or fall as investors flee to safety.
(Washington)
All eyes on the Fed. Not only is the winding down of the Fed’s balance sheet a potentially major issue to Dollar liquidity and emerging markets, but the market has rate worries to deal with. The big question is how low the US jobless rate can go before it sparks big inflation. Currently sitting at 3.8%, the Fed needs to decide how long it can tolerate the hot market before hiking rates quickly. The US jobless rate has only twice been so low. Once in the 1960s, which led to a decade of high inflation, and once in 2000, which was followed by a recession.
FINSUM: There is currently a big disconnect between the rate rises the market is pricing in versus what the Fed is forecasting. The market may lose that gamble very badly.
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(New York)
Investors beware, the fundamentals of the junk bond market are looking terrible. The deterioration of the market has been happening for a long time, and thus it makes it easier not to realize it. The junk bond market is now about twice the size it was in 2007, and credit quality is lower. Protections for investors, in the form of covenants, are also much weaker as issuers were able to use the ultra-low rate market to their advantage. Now the big worry is that Libor is rising and many companies have floating rate debt that they cannot cover once it reaches certain levels.
FINSUM: According to the WSJ, the market should expect $500 bn of junk bond defaults over the next three years, and this figure could amplify considerably.
(New York)
Investors hang onto your hats, a big fixed income rout might be coming. While it was easy to write Italy’s big bond losses off to its recent political crisis, the Wall Street Journal is arguing that all risky bonds may be in for a reckoning. There are a couple reasons. One is that just as in Italy’s two-year bond, many fixed income securities may hit a “double bottom”, which could lead to serious losses. But more fundamentally, many investors are now starting to view bonds higher up the quality spectrum more favorably, which means the market may suffer a significant “risk-off” period. Global high-yield bonds are down almost 4% already this year.
FINSUM: Our bigger worry than the points mentioned here is that as safer bonds start to get better yields from rising rates, there is less and less incentive to buy junk. That is a major change from the paradigm of the last few years.
(New York)
Safe 5% yields sound very enticing right now don’t they? Well, they are actually not as hard to find as you think if you take a broader perspective. That perspective is to look at standard municipal bonds and examine their real-world yields, or how they compare to taxable bonds. For instance, for a couple living in California with a $250k per year income, a municipal bond yielding 3.0% is equivalent to a taxable bond yielding a whopping 5.8%. This is because of the new tax system brought in by Republicans. One muni expert comments that “I would argue that munis are more attractive than they’ve ever been because, with the loss of various deductions, including SALT, one’s taxable income is higher than it’s ever been”.
FINSUM: This is a very good insight and one to which HNW individuals and advisors need to pay attention. Once investors really come around to this, it could spark a muni bond run.