Update on Global High Yield Debt Issuance Volumes

Here is a small addendum to our recent articles on the corporate debt bubble (“A Dangerous Boom in Unsound Corporate Debt”) and the associated derivatives-berg, which is intended to hedge both the credit and interest rate risk this credit boom has given rise to (“A Perilous Derivatives-Berg”).

We recently combed through John Hussman's weekly commentaries, one of which contained an up-to-date chart of global high yield debt issuance per quarter from Q1 2006 to Q2 2014. Both global issuance volume and the number of deals are depicted on the chart. As you can see, we have long left all previous records in the dust.

 

hi-yieldGlobal high yield debt issuance in USD billion per quarter, plus the number of offerings, via John Hussman.

 

How Compressed Risk Premiums Unwind

This low-grade debt bubble is undoubtedly going to prove to be the Achilles heel of the current inflationary boom period – even though many market participants strenuously deny it by relying on the 12 month default forecasts published by rating agencies (which show not even the smallest cloud on the horizon – in other words, it's all good). As the next chart shows, risk premiums have become extremely compressed. Mr. Hussman had something very interesting to say on that particular topic, namely:

 

“As we saw in multiple early selloffs and recoveries near the 2007, 2000, and 1929 bull market peaks (the only peaks that rival the present one), the “buy the dip” mentality can introduce periodic recovery attempts even in markets that are quite precarious from a full cycle perspective. Still, it's helpful to be aware of how compressed risk premiums unwind. They rarely do so in one fell swoop, but they also rarely do so gradually and diagonally. Compressed risk premiums normalize in spikes.

As a market cycle completes and a bull market gives way to a bear market, you’ll notice an increasing tendency for negative day-to-day news stories to be associated with market “reactions” that seem completely out of proportion. The key to understanding these reactions, as I observed at the 2007 peak, is to recognize that abrupt market weakness is generally the result of low risk premiums being pressed higher. Low and expanding risk premiums are at the root of nearly every abrupt market loss. 

Day-to-day news stories are merely opportunities for depressed risk premiums to shift up toward more normal levels, but the normalization itself is inevitable, and the spike in risk premiums (decline in prices) need not be proportional or “justifiable” by the news at all.

Remember this because when investors see the market plunging on news items that seem like “nothing,” they’re often tempted to buy into what clearly seems to be an overreaction. We saw this throughout the 2000-2002 plunge as well as the 2007-2009 plunge.”

 

(emphasis added)

This is an important observations regarding the connection between news releases and financial markets. The news are actually rarely the cause of market movements (which more often than not makes the attempts in the financial press to “explain” day-to-day market movements incredibly comical).

Market participants only use news as triggers when it suits them, in other words, when they seem to confirm what they were going to do anyway. The important point is not whether news emerge that are seemingly associated with market moves; the important point is the degree of overvaluation and leverage.

 

Hi Yield, effective

Effective yield of the Merrill US high yield master II index – currently at 5.5%. Similar levels of return-free risk were on offer in 2005-2007 – click to enlarge.

 

Comforting Myths

Hence there rarely seems to be a “reason” for why market crashes happen. Market observers are e.g. debating to this day what actually “caused” the crash of 1987. It is in the nature of the beast that once liquidity evaporates sufficiently that not all bubble activities can be sustained at once any longer, bids begin to become scarce in one market segment after another. Eventually, they can disappear altogether – and sellers suddenly find they are selling into a vacuum.

Once this happens, the usual sequence of margin calls and forced selling does the rest. Risk premiums normalize abruptly, and there doesn't need to be an obvious reason for this to happen. Mr. Hussmann inter alia cites Kenneth Galbraith's description of the crash of 1929 in this context. Galbraith correctly remarked that when the crash occurred, no-one knew that a depression was lying dead ahead. The crash itself would have been in the cards regardless of what happened later. Anything could have broken the bubble, as Galbraith put it. The crash merely adjusted a situation that had become unsustainable.

After an extended credit boom, leverage can be assumed to have seeped into every nook and cranny of the markets.  In the stock market, we see it in record high margin debt and the tiny cash reserves held by mutual funds and other investors. In fixed interest rate securities, investors are encouraged by low volatility and the seeming absence of risk to lever up, as their returns on newly issued debt begin to shrink along with falling interest rates. In so doing, the risks are usually judged by looking at market history. In every bubble, a new myth emerges that seemingly justifies such investment decisions.

In the housing bubble, the myth of choice was that house prices could never fall on a nationwide basis. After all, history showed it had never happened before. It was held that eventually, problems may emerge in some regions or some sub-sectors of the credit markets, but they would remain localized and “well contained” (the favorite phrase employed by assorted officials when the bubble began to fray at the edges). In the current bubble the myth of choice is that “past crises have shown that defaults on high yield corporate debt never exceed certain manageable levels”.

Why is this a myth? After all, it is a historically correct view. It is a myth for one reason only: in all of history, there has never been a bigger bubble in junk debt than now (just as the real estate and mortgage credit bubble were unique in their extent). Therefore, economic history actually has little to say about the current situation, except for the general statement that compressed risk premiums have a tendency to one day readjust out of the blue and quite abruptly. Economic history can definitely not be used to assert that the risks are small. They are in fact huge and continue to grow.

 

Conclusion

Compressed risk premiums can never be sustained “forever”. They are so to speak sowing the seeds of their own demise. Most market participants believe they will be able to get out in time, but that is never the case – in fact, it is literally impossible for the majority to do so, because someone must buy what others sell (by definition, this means someone will be caught holding the bag when the tide goes out). In reality, it is ever only a tiny minority that manages to sell near the market peak, not least because investors have assimilated the lesson that “every dip is a buying opportunity”. This will be true until it one day isn't anymore (the search for reasons will then predictably yield the well-known phrase “no-one could have seen it coming”).

 

Charts by John Hussman, St. Louis Federal Reserve Research

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “Comfortable Myths About High Yield Debt”

  • Hans:

    Neither of these two charts are very comforting.

    Somewhere, down the road, at which mile marker I do not known,
    there will be a very bad crash.

    The first responders (Central Banks) will appear at the ghastly site
    and utter, there is nothing we can do, other than to carry away the corps.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • India: The World’s Fastest Growing Large Economy?
    Popular Narrative India has been the world’s favorite country for the last three years. It is believed to have superseded China as the world’s fastest growing large economy. India is expected to grow at 7.5%. Compare that to the mere 6.3% growth that China has “fallen” to.   India's quarterly annualized GDP growth rate since 2008, according to MOSPI (statistics ministry) - click to enlarge.   The IMF, the World Bank, and the international media have celebrated...
  • Gold Sector Update – What Stance is Appropriate?
      The Technical Picture - a Comparison of Antecedents We wanted to post an update to our late December post on the gold sector for some time now (see “Gold – Ready to Spring Another Surprise?” for the details). Perhaps it was a good thing that some time has passed, as the current juncture seems particularly interesting. We received quite a few mails from friends and readers recently, expressing concern about the inability of gold stocks to lead, or even confirm strength in gold of...
  • Don’t Blame Trump When the World Ends
    Alien Economics There was, indeed, a time when clear thinking and lucid communication via the written word were held in high regard. As far as we can tell, this wonderful epoch concluded in 1936. Everything since has been tortured with varying degrees of gobbledygook.   One should probably not be overly surprised that the abominable statist rag Time Magazine is fulsomely praising Keynes' nigh unreadable tome. We too suspect that this book has actually lowered the planet-wide IQ –...
  • What is the Best Time to Buy Stocks?
      Chasing Entry Points Something similar to the following has probably happened to you at some point: you want to buy a stock on a certain day and in order to time your entry, you start watching how it trades. Alas, the price rises and rises, and your patience begins to wear thin. Shouldn't a correction set in soon and provide you with a more favorable buying opportunity?   Apple-Spotting – a five minute intraday chart showing the action in AAPL on February 1, 2017 - an...
  • Incrementum Advisory Board Meeting, Q1 2017 and Some Additional Reflections
      Looming Currency and Liquidity Problems The quarterly meeting of the Incrementum Advisory Board was held on January 11, approximately one month ago. A download link to a PDF document containing the full transcript including charts an be found at the end of this post. As always, a broad range of topics was discussed; although some time has passed since the meeting, all these issues remain relevant. Our comments below are taking developments that have taken place since then into...
  • Trump and the Draining of the Swamp
      Swamp Critters BALTIMORE – The Dow is back above the 20,000-point mark. Federal debt, as officially tallied, is up to nearly $20 trillion. The two go together, egging each other on. The Dow is up 20 times since 1980. So is the U.S. national debt. Debt feeds the stock market and the swamp. What’s not up so much is real output, as measured by GDP. It’s up only 6.4 times over the same period. Debt and asset prices have been rising three times as fast as GDP for 36 years! Best...
  • Gold and Silver Divergence – Precious Metals Supply and Demand
      Gold and Silver Divergence – Precious Metals Supply and Demand Last week, the prices of the metals went up, with the gold price rising every day and the silver price stalling out after rising 42 cents on Tuesday. The gold-silver ratio went up a bit this week, an unusual occurrence when prices are rising. Everyone knows that the price of silver is supposed to outperform — the way Pavlov’s Dogs know that food comes after the bell. Speculators usually make it...
  • Making America Great Again – How to Judge Policy
      A Simple Formula MIAMI – How do we know if new programs will make the economy better... or worse? Here’s a simple formula:   W = rv (w-w – w-l)   That is, wealth is equal to the real value of win-win exchanges minus the loss from win-lose exchanges. Yes, dear reader, it’s as simple as that. Like a whittler working on a piece of wood, we’ve shaved so much off, there is nothing left of it... except the essential heartwood.   When devising a win-win,...
  • When Trumponomics Meets Abenomics
      Thirty Year Retread What will President Trump and Japanese Prime Minister Shinzo Abe talk about when they meet later today? Will they gab about what fishing holes the big belly bass are biting at? Will they share insider secrets on what watering holes are serving up the stiffest drinks? [ed. note: when we edited this article for Acting Man, the meeting was already underway]   Japan's prime minister Shinzo Abe, a dyed-in-the-wool Keynesian and militarist, meets America's...
  • The Great Wailing
      Regret and Suffering BALTIMORE – Victoribus spolia... So far, the most satisfying thing about the Trump win has been the howls and whines coming from the establishment. Each appointment – some good, some bad from our perspective – has brought forth such heavy lamentations.   Oh no! Alaric the Visigoth is here! Hide the women and children! And don't forget the vestal virgins, if you can find any...   You’d think Washington had been invaded by Goths, now...
  • Receive a One Percent Gift When Buying or Selling a Home
      How to Save Money When Buying or Make More When Selling a Home In your professional capacity and perhaps also in your private life, you may be closely involved with financial and commodity markets. Trading in stocks, bonds or futures is part of your daily routine.  Occasionally you probably have to deal with real estate as well though – if you e.g. want to purchase an apartment or a house, or if own a home you wish to sell.   The people who took this photograph probably want to...
  • Silver Futures Market Assistance – Precious Metals Supply and Demand
      Silver Is Pushed Up Again This week, the prices of the metals moved up on Monday. Then the gold price went sideways for the rest of the week, but the silver price jumped on Friday.   Taking off for real or not? Photo credit: NASA   Is this the rocket ship to $50? Will Trump’s stimulus plan push up the price of silver? Or just push silver speculators to push up the price, at their own expense, again? This will again be a brief Report this week, as we are busy...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com