Tag Archives: HYG

The S&P 500 Is Set Up To Crash

Let me preface this commentary with the proviso that none of us has any idea the extent to which the Fed and the Working Group On Financial Markets, which has its offices in the same building as the NY Fed, has the ability to prevent a stock market accident.

Having said that, a large portion of the stock market has been in a tail-spin. The Dow Jones Transports Index is down over 18% from its peak last November; the SPDR retail ETF, XRT, is down 15% from mid-July this year; the iShares Biotech ETF, IBB, is down 18% since its high close in mid-July – perhaps ironically one day after XRT closed at its high; AAPL is down 20.3% from its February 23, 2015 all-time high – technically AAPL is now in a bear market; Dow Jones homebuilder/construction index, DJUSHB, is down over 10% from its high close (not even close to all-time high) in August – notwithstanding all the other fundamental headwinds starting blow at housing with full force, hiking interest rates will act like a roadside bomb on the housing market.

The point here is that many sub-sectors of the NYSE, sectors which had been extraordinarily hot as Untitled1stock trades, are now reflecting the truth about the deteriorating condition of the U.S. economy. (click on image to enlarge).

We can dissect the debate over the reasons why the Fed has decided to start “normalizing” – whatever that means – interest rates now. The fact of the matter is that it is impossible to know for sure why the Fed decided to nudge the Fed funds rate up by one-quarter of one percent. What we know based on reams of empirical evidence is that the U.S. economy is now collapsing at the rate it was collapsing in 2008/2009. Unless the FOMC is completely brain-dead – a consideration I would not fully dismiss – the Fed must have had some ulterior for setting a posture of tighter monetary policy.

With the high yield, and now investment grade, bond sectors imploding (I suggested over 2 weeks ago that the virus infecting the junk bond market would spread to investment grade), the next part of the capital structure that will be attacked is the equity “layer.” Many of you might have missed this news release yesterday:  Fed Votes To Limit Bailouts. The Fed is now restricted legally in the scope of its ability to prop up crashing banks.  There has to be a reason this legal restraint was allowed to be executed, because certainly the big banks and the Fed had the ability to derail it.  Perhaps it’s just putting window dressing on impending market developments that the Fed is now powerless to prevent anyway.

I have suggested for quite some time that eventually the natural forces of the market could not be prevented from seizing the S&P 500 and pulling it down to a level that reflects the true underlying economic and fundamental conditions from which markets derive their intrinsic over long periods of time.  History has already shown us many times that market interventions never work indefinitely.  Just ask OPEC.

Again, it’s impossible to time the markets perfectly, but the probability of a big downside event in the stock market is now highly skewed in the favor of those who set up their market bets to take advantage of the coming downside action.  My SHORT SELLER’S JOURNAL is a weekly subscription service, delivered to your email on Sunday night or Monday morning, is a market briefing with two ideas for shorting the market.  I also include some market comments not covered in this blog.

This week I will be featuring a financial stock and some interesting information on the housing market that you won’t see anywhere – at least not at this point.  You can subscribe to this service by clicking here:   SHORT SELLER’S JOURNAL.  If you subscribe by Sunday afternoon, you’ll get last week’s report plus this upcoming report.

Is The Fed Trying To Arrange A Bailout Of Junk Bond Funds?

Warning #3:   If you are hesitant to sell your bond funds, use any bounce in the junk bond market to get out of all fixed income funds.  Someone asked me the other day about Treasury funds.   Go read the fine print in the prospectus.  You can find it online.  If the fund permits the use of derivatives, get out of it.  100’s of thousands of investment advisors and retail investors loaded up on Pimco’s Total Rate of Return fund having no idea that it is riddled with derivatives.   If you own Black Rock funds, don’t wait for a bounce.  Just get out.  Black Rock is the financial market version of Fukushima.

I heard a rumor today that the Fed is trying to solicit “fire sale” liquidity bids from private equity funds for big chunks of the bonds held by high yield mutual funds and ETFs.  I want to emphasize that this is an unsubstantiated rumor but it comes from a good source.

At this stage in the game, I believe the Fed will do anything possible to keep the system from collapsing.  On the assumption that the rumor is valid – which I would suggest has a 95% level of probability – I would also expect to see the Fed, in conjunction with the Treasury, offer private equity firms zero-percent credit lines in order incentivize and facilitate an attempted bailout of the junk market by private equity funds.  After all, this would be a no-risk opportunity for the managers of these funds to throw their growing cash piles at something besides Silicon Valley unicorns in order to put the cash to work and skim fees off the invested capital.

Of course at the end of the day, if this scenario plays out, it will be just another attempt to kick the proverbial can down the road and forestall the inevitable collapse of the financial system.  Unfortunately the fundamentals which support the idea that there’s any intrinsic value in the majority of the junk paper that has been issued over the past five years continue to deteriorate.

The primary reason for the Fed to prop up the junk bond market is to prevent the stock market fromUntitled collapsing.  The graph on the right shows what’s at stake (click to enlarge).   At some point the performance of the S&P 500 and the high yield bond market will be forced by the market to re-correlate.  I highly doubt that high yield bonds will converge up to the stock market.

The graph below on the left shows that leveraged loans, which sit on top of junk bonds in the capital structure, are chasing junk bonds in a race to the bottom now.  Theoretically, to the extent the the top of the Untitled1capital structure – leveraged loans – are valued at less than 100 cents on the dollar, everything below them is worth zero.  In a strict application of bankruptcy law, liquidation payouts go from top to bottom.  However, for practical purposes, bankruptcy workouts typically sprinkle some of the agreed restructuring value to the debt tranches below the senior secured level.  If for nothing else than to prevent lawyers from cannibalizing any remaining value with fees.

As you can probably guess, if senior secured debt and junk bonds are worth substantially below par, the equity is worth zero.   THAT is why the stock market eventually follows the junk bond market lower.  THAT is the dynamic that the Fed will attempt to prevent using any possible means at its disposal – legal and illegal.

History tells us this will eventually fail.   The degree to which the end result is catastrophic is always directly proportional to the amount of effort that went in to the attempt to prevent the inevitable.

You can make money off of this inevitability by shorting the stock market.  As this unfolds, there is a lot of money to be made shorting all of the hideously overvalued stocks.   My new subscription service will be rolling out two ideas per week that will help you find ways to exploit the gross price distortions and sector bubbles that have developed after 6 years of extremely reckless monetary policy by the Federal Reserve and U.S. Treasury.    You can subscribe by clicking here:   SHORT SELLER’S JOURNAL.

Ominous Signals Coming From The High Yield Market

Are you prepared for impact? One of my readers alerted me to the fact that someone bought 15,000 January 2016, 80-strike puts on the HYG high yield bond ETF. That’s a $1.6 million cash bet on an event that has not occurred since July 2009.

The high yield bond indices are rolling over quickly.  As the graph below shows, after the QE-driven big bounce from the 2008 collapse in the financial markets, the high yield market has largely drifted sideways since the middle of 2010.   Energy bonds represent about 15% of the high yield market.  But the junk bond market actually began slowly rolling over a full year before the price of oil collapsed:

Untitled1

You see that the junk bond market, as represented by the HYG ETF, peaked in July 2013. The price of oil began to drop like a rock in mid-June 2014. This event didn’t seem to infect the junk bond market until early July 2014.

For a lot of reasons, the high yield market is a lot more sensitive to changes in the financial and economic condition of the system than are stocks. From the graph above, you can see that HYG is down 12.5% from its peak in 2013. At that point in time, the S&P 500 was still on its way to an all-time high. More than half of the 12.5% drop in junk bonds has occurred since the spring of 2015.

The story got a lot more interesting today.  A reader of my blog emailed that someone had bought 15,000 January 2016, 80-strike put options on HYG today (Wed, 9/23).  Here’s the tape – click to enlarge:

Untitled

Assuming an average price paid for the puts of $1.08, which was the last trade price in the option contract, someone plunked down $1,620,000 to buy puts on HYG with a strike price set at $80. But as you can see from the graph above, HYG has not closed below $80 since July 17, 2009. In fact, it really hasn’t even “sniffed” the low 80’s since late 2011.

In other words, someone pulled $1.6 million out of their pocket to speculate on what, up until now, has been a very low probability occurrence for the last 6 years.

You can see from the graph that if the financial system melts down before the end of the year, and I believe this event is quite possible, HYG could plunge. If it were to do a cliff-dive before mid-January down the the $62 level it hit in early 2009, the value of this put bet will soar to $27 million.

One last note, historically, the big movements in the junk bond market tend to lead big movements in the stock market. If this guy is right on the timing of his bet on the junk market, the stock market will crash before Christmas.

The economic fundamentals are highly supportive of this thesis, at this point it’s only a question of whether or not the monkeys at the Fed are losing their  ability to rig the markets.  I know several market analysts each with decades of experience who think this is the case, including me.