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:

  • Gold – An Overview of Macroeconomic Price Drivers
      Fundamental Analysis of Gold As we often point out in these pages, even though gold is currently not the generally used medium of exchange, its monetary characteristics continue to be the main basis for its valuation. Thus, analysis of the gold market requires a different approach from that employed in the analysis of industrial commodities (or more generally, goods that are primarily bought and sold for their use value). Gold's extremely high stock-to-flow ratio and the main source of...
  • Doomsday Device
      Disappearing Credit All across the banking world – from commercial loans to leases and real estate – credit is collapsing. Ambrose Evans-Pritchard writing for British newspaper The Telegraph:   Credit strategists are increasingly disturbed by a sudden and rare contraction of U.S. bank lending, fearing a synchronized slowdown in the U.S. and China this year that could catch euphoric markets badly off guard. Data from the U.S. Federal Reserve shows that the $2 trillion market...
  • India – Is Kashmir Gone?
      Everything Gets Worse  (Part XII) -  Pakistan vs. India After 70 years of so-called independence, one has to be a professional victim not to look within oneself for the reasons for starvation, unnatural deaths, utter backwardness, drudgery, disease, and misery in India. Intellectual capital accumulated in the West over the last 2,500 years — available for free in real-time via the internet — can be downloaded by a passionate learner. In the age of modern technology, another mostly...
  • Pulling Levers to Steer the Machine
      Ticks on a Dog A brief comment on Fed chief Janet Yellen’s revealing speech at the University of Michigan. Bloomberg:   “Before, we had to press down on the gas pedal trying to give the economy all of the oomph that we possibly could,” Yellen said Monday in Ann Arbor, Michigan. The Fed is now trying to “give it some gas, but not so much that we’re pushing down hard on the accelerator.” […] “The appropriate stance of policy now is closer to, let me call it...
  • Credit Contraction Episodes
      Approaching a Tipping Point Taking the path of least resistance doesn’t always lead to places worth going.  In fact, it often leads to places that are better to avoid.  Repeatedly skipping work to sleep in and living off credit cards will eventually lead to the poorhouse.   Sometimes the path of least resistance turns out to be problematic   The same holds true for monetary policy.  In particular, cheap credit policies that favor short-term expediency have the...
  • Cracks in Ponzi-Finance Land
      Retail Debt Debacles The retail sector has replaced the oil sector in a sense, and not in a good way. It is the sector that is most likely to see a large surge in bankruptcies this year. Junk bonds issued by retailers are performing dismally, and within the group the bonds of companies that were subject to leveraged buyouts by private equity firms seem to be doing the worst (a function of their outsized debt loads). Here is a chart showing the y-t-d performance of a number of these...
  • Mea Culpa – Precious Metals Supply and Demand
      Input Data Errors Dear Readers, I owe you an apology. I made a mistake. I am writing this letter in the first person, because I made the mistake. Let me explain what happened.   The wrong stuff went into the funnel in the upper left-hand corner...   I wrote software to calculate the gold basis and co-basis (and of course silver too). The app does not just calculate the near contract. It calculates the basis for many contracts out in the distance, so I can see the...
  • French Election – Bad Dream Intrusion
      The “Nightmare Option” The French presidential election was temporarily relegated to the back-pages following the US strike on Syria, but a few days ago, the Economist Magazine returned to the topic, noting that a potential “nightmare option” has suddenly come into view. In recent months certainty had increased that once the election moved into its second round, it would be plain sailing for whichever establishment candidate Ms. Le Pen was going to face. That certainty has been...
  • The Cost of a Trump Presidency
      Opportunity Cost Rears its Head Last Thursday’s wanton attack on a Syrian air field by the US and its bellicose actions toward North Korea have brought the real cost of candidate Trump’s landslide victory last November to the forefront.   It didn't take long for Donald Trump to drop his non-interventionist mask. The decision was likely driven by Machiavellian considerations with respect to domestic conditions, but that doesn't make it any better.   Unlike...
  • Heavily Armed Swamp Critters
      Worst Mistake GUALFIN, ARGENTINA – By our calculation, it took just 76 days for President Trump to get on board with the Clinton-Bush-Obama agenda. Now there can be no doubt where he’s headed. He’s gone Full Empire. Not that it was unexpected. But the speed with which the president abandoned his supporters and went over to the Deep State is breathtaking.     Once there was only a Trump fragrance called Empire... now he has gone full empire himself   Among the noise...
  • Hell To Pay
      Behind the Curve Economic nonsense comes a dime a dozen.  For example, Federal Reserve Chair Janet Yellen “think(s) we have a healthy economy now.”  She even told the University of Michigan’s Ford School of Public Policy so earlier this week.  Does she know what she’s talking about?   Somehow, this cartoon never gets old...   If you go by a partial subset of the ‘official’ government statistics, perhaps, it appears she does.  The unemployment...
  • Trump Is An Insider Now
      Conspiracy of the Few GUALFIN, ARGENTINA – “U.S. stocks fall on Trump talk…” began a headline at Bloomberg. Or it may be Trump action. We had already counted six major campaign promises – including no O’care repeal and no “America First” foreign policy – already buried (some for the better).   A bunch of campaign promises get the MOAB treatment...  A great many  theories have been proposed to explain Trump's recent series of u-turns: 1. he is in thrall to...

Support Acting Man

Austrian Theory and Investment

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