The junk bond bubble has exploded. Yesterday a public mutual fund “specializing” in the lowest-rated segment of junk bond market announced that it was suspending redemptions and liquidating its assets. It’s debatable whether or not it will be able to sell the nuclear garbage in the fund unless the Fed prints up some money and buys it.
Today Stone Lion Capital Partners gated one of its hedge funds “specializing” in distressed debt (defaulted and near-default bonds and bank debt). Interestingly, Stone Lion was founded by two former Bear Stearns employees after Bear Stearns choked to death on fraudulent mortgage paper. Stone Lion disclosed that it had received redemption requests that were significantly in excess of its ability to sell enough holdings in the fund to meet the requests.
This brings up the issue of “mark to market.” If the fund industry was marking its positions accurately based on where they could sell a meaningful amount of their holdings, this would not be a problem. As I stated earlier this week, the entire high yield bond universe – including the pension funds who have a material exposure to the junk bond market – had been keeping their positions marked at unrealistically high levels and holding their breath in hopes that no one would have to sell and disprove the mark levels.
But “hope” is not a valid investment strategy. I have personally lived through this nightmare, although on a tiny fraction of the scale that it is occurring now.
Blackrock (BLK) is the poster boy for credit market mutual funds. Blackrock’s funds are riddled with illiquidity, derivatives and bad investments. The stock is down over 11% in the last 10 trading days. It plunged 6.5% today.
If you are invested in junk bond funds it may be too late. I suspect that several other funds will lower the “gate” on redemptions starting this weekend. You may as well write off most of your investment off in these funds.
But it is likely not too late to get out of any other fixed income funds. I am advising anyone reading this to get out of any investment grade corporate or mortgage bond funds. The melt-down in the high yield market is going to spread quickly to the entire credit market. Foretold is forewarned.
Everyone is worried about what will happen if the Fed nudges the Fed funds rate up a microscopic amount next week. But the planetary-system sized bubble that has inflated would never have been possible without the Fed’s monetary policies. Get out while you still can because the window to slip through is closing quickly.
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