Junk Bond Bubble in Six Images

The junk bond to BBB-rated bond spread and the spread between AAA to BBB bonds shows amazing complacency. It won't last.

Fallen Angels

BBB-rated bonds are just one notch above junk (also called high-yield).

Fallen angels are bonds that slip from BBB to junk.

The lead chart shows what happens to "fallen angels" during recessions. All the investment grade bond funds have to dump the fallen angels straight into illiquid markets with few takers.

Half of the corporate bond universe is BBB-rated.

Fallen Angels vs BBB Yield

I created the BBB to Junk spread chart by subtracting the BBB yield from the High Yield yield.

BBB vs AAA Yield

BBB to AAA Yield Spread

Investors’ Curious Comfort With Junk Bonds

The Wall Street Journal comments on Investors’ Curious Comfort With Junk Bonds

The above image is from the WSJ. It only went back to 2016 so I created the top four charts in Fred to better show what's really going on.

> As Treasury yields rise, corporate bonds are getting whipped by the storm. But there’s still a danger investors aren’t getting paid enough for the risks they are taking.

> A close look at U.S. bond markets reveals little evidence of a systemic flight from risk amid last week’s auctions. Yields haven’t yet risen much compared with recent years even as investors have withdrawn billions from corporate-bond funds.

> All year, investment-grade bonds have performed worse than riskier debt. Meanwhile, the spread on junk bonds hasn’t yet increased enough to break out of the generally downward trend that has lasted almost three years.

> However, given that the U.S. and global economies are very far into a long period of growth and more interest-rate rises are in the cards, investors should be more concerned that they aren’t getting paid enough for the risk of downgrades and, potentially, defaults when the slowdown comes.

> The selloff in corporate debt has barely started.

That last line says it all.

Here are two more charts to wrap things up.

Junk Bond vs. S&P 500

What to Expect

When the junk bond market does blow, it is nearly guaranteed to take equities with it. That's the scary thing about the recent equity selloff.

The junk bond market selloff has barely started and so has the accompanying stock market decline.

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Mike "Mish" Shedlock

Comments (9)
No. 1-6
Bam_Man
Bam_Man

In the next recession ALL the debt issued to do insane acquisitions (ie IBM buying Red Hat and paying 11x SALES) and to buyback their own shares at preposterously high prices will ALL default. It will not just be "Junk" bonds. And BTW, has anyone looked at where the oil price has been heading lately? I doubt that many in the Fracking business have positive cash flow at anywhere near the current price.

oudaveguy98
oudaveguy98

This kind of analysis is why I come here. Oh, and the political commentary!

Stuki
Stuki

High yield debt, is pretty much free money if you're an entity who believe you can lay claim to the coveted, and of course arbitrary as always in dystopia, "systemically important" title. Something more and more entities believe they are entitled to. Public pension funds, money center banks, what have you.

Buy obviously bad risks on the cheap, pretend it's money good when calculating bonuses; throw your arms up in the air and cry about "the system." And about how retired people, who have "put money in," are "starving in the streets," when reality comes home to roost..... Then sit back and laugh as the scum-with-the-guns rob someone else to soothe your tantrum... Something well indoctrinated idiots will inevitably believe is "fair." Since some guy named "we", like "voted" for them and all...

gregggg
gregggg

AWC
AWC

Something tells me the next wages report is going to blow all this doom stuff away😉

Casual_Observer
Casual_Observer

I dumped all high yield crap a few months ago in favor of cash. The bond market will seize up and take equities with it. The wage picture while improved will pale in comparison to health care and other costs. Most Americans have no idea what's about to happen because they don't understand bonds and how they impact the broader economy.