It’s about money, whether the headlines are horrific cases of bride burning, or a knockout in an elevator with an NFL sports star. Despite the myriad reasons women have been
September Blues and Fed Speak Continue reading →
The best trading idea is to assume when the next crash occurs in 1.5 or 2 years it will start with a meltdown in high yield corporate junk bonds. This asset class has been the most abused during the current recovery cycle. Investors fantasize that a bond, being a promise to pay face value, is somehow a low risk asset but this is only true with investment grade bonds. During an abusive part of the credit cycle when bond investors forget about credit crashes and start to dream that the only risk is inflation and duration risk that is when issuers and investment bankers peddle aggressive, dangerous junk bonds. The time to failure on a new loan is a “tail” of about 18-24 months, so starting about two years after 2013 or 2014 a lot of junk bonds will default. During the first three years after the 2009 bottom issuers couldn’t get away with offering really risky debt but as the Federal Reserve lowered rates then investors became careless and bought too many new junk bonds which lack traditional bond covenants so they are riskier. There are many news stories about borrowers paying 15% and junk bond Closed End mutual funds yielding 9 to 11%. There was a story about business borrowers paying 30% (that’s thirty%!!!) and how investors were happy to get part of this yield after the finance company took its share. If someone has to pay 15% to borrow when the Fed Funds rate is almost zero that borrower is extremely risky. At that level the odds are high the borrower will fail in a few years. If too many of these type of borrowers fail at the same time in a few years it will be the trigger point for a general crash of all risk assets such as stocks and real estate.
Shorting junk bonds is difficult, both to borrow them, and to pay the yield to the person who you borrowed the assets from. Buying a Credit Default Swap (CDS) that insures against the risk of junk bond failure would better but they aren’t available for retail investors. Perhaps one could buy Puts on the stock of a commercial finance company that specializes in high yield corporate junk loans. At least one should avoid owning junk bonds since one never knows the exact moment the earthquake will hit.
Other factors that could trigger the next stock crash would be rising inflation and interest rates, or rising wages that would hurt corporate profits. I feel the ultra-low growth rates make this unlikely; what is more likely is that every seven or eight years the economic cycle falters triggering a new wave credit defaults and inventory selloffs. That implies another 1.5 to 2.5 years before the next crash. The Fed’s regime of low rates has set up to failure those marginal borrowers who could only get a junk bond type of financing. Mortgages are not very risky because of strict underwriting; instead it is junk quality corporate debt (either loans or bonds) that is a very obvious contingent risk. It will be the canary in the coal mine during the next crash.
EM bonds are mostly below investment grade so these too could be a source of sudden defaults. The greatest risk is in the lowest rungs of ratings at the “C” level. Debt rated one notch below investment grade (BB) is not too risky but it is best to keep your holdings at a modest amount.
Besides the risk of domestic “C” grade junk bonds defaulting the risk that EM junk borrowers could suddenly default is a serious concern. EM countries have a way of propping up their economy too much and when the funds to prop it up are exhausted then their government’s sudden abandonment of the economy makes their crashes swifter and more startling than one might expect. Some EM countries have less than optimal accounting and auditing systems so the risk that a sudden surprise downgrade of credit quality or default could occur is a serious concern for investors to weigh.
Investors need independent financial advice about the risk of sudden junk bond defaults and how they could trigger a stock crash.
San Francisco Research Paper Moves Interest Rates Continue reading →
Read any financial column or blog and chances are the writers (including yours truly) have advocated that readers save their income, reduce expenses and get rid of debt. Sometimes this valuable information can get interpreted as you can never spend any money on yourself for little things here and there such as a meal out or grabbing a movie with a friend. These little things can help keep you on track for your bigger savings targets by allowing you a bit of autonomy and a chance to enjoy the money you’re working hard to earn and save. Think of it this way: let’s say someone is going on a diet and they absolutely refuse to eat any type of sweet, junk food or anything that would keep them from getting to the proper fitness level or weight they are looking to achieve. What can (and usually does) happen is by […]
Welcome to the next installment in our series of Key Investment Insights. In our last piece, “Smoothing the Investment Ride,” we discussed the benefits of diversifying your investments to minimize avoidable risks, manage the unavoidable ones that are expected to generate market returns, and better tolerate market volatility. The next step is to understand how […]
|SITE LINKS||COMPANY INFORMATION||FINANCIAL ADVICE GUIDES|