Tag Archives: junk bonds

Could GE’s Slow Collapse Ignite A Financial Crisis?

Will GE be the proverbial “black swan?” – It had come to my attention that General Electric was locked out of the commercial paper market three weeks ago after Moody’s downgraded GE’s short term credit rating to a ratings level (P-2) that prevents prime money market funds from investing in commercial paper. Commercial paper (CP) is an important source of short term, low-cost, liquid funding for large companies. At one point, GE was one of the largest users of CP funding. As recently as Q2 this year, 14.3% of GE’s debt consisted of CP. Now GE will have to resort to using its bank revolving credit to fund its short term liquidity needs, which is considerably more expensive than using CP.

Moody’s rationale for the downgrade was that, “the adverse impact on GE’s cash flows from the deteriorating performance of the Power business will be considerable and could last some time.” Keep in mind that the ratings agencies, especially Moody’s, are typically reluctant to downgrade highly regarded companies and almost always understate or underestimate the severity of problems faced by a company whose fundamentals are rapidly deteriorating.

As an example, Moody’s had Enron rated as investment grade until just a few days before Enron filed bankruptcy. At the beginning of November 2001, Moody’s had Enron rated at Baa1. This is three notices above a non-investment grade rating (Ba1 for Moody’s and BB+ for S&P). Currently Moody’s and S&P have GE’s long term debt rated Baa1/BBB+. In the bond market, however, GE bonds are trading almost at junk bond yields.

Once a company that relies on cheap short-term funding is locked out of the commercial paper market, it more often than not precedes the rapid financial demise of that company. Because GE is GE, it may not be rapid, but I would bet GE is on the ropes financially and could go down eventually. GE’s CEO was on CNBC two weeks ago on a Monday proclaiming that the Company’s number one priority is to bring “leverage levels down” using asset sales. One asset GE is said to be considering selling is its aviation unit, which is considered its crown jewel. This is the classic signal that a company is struggling to stay solvent – i.e. burning furniture to keep the lights on and heat the house. It’s not a bad bet that GE might file chapter 11 – or even Chapter 7 liquidation – in the next 18-24 months (maybe sooner).

I wanted to discuss this situation because I opined on Twitter recently that a sell-off in GE’s stock below $5 could trigger an avalanche of selling in the stock market. Just as significant, an event in which a company like GE is shut off from commercial paper funding is the type of “pebble” that is tossed onto an unstable financial system and starts a credit market crisis. The downgrade of GE’s short term funding rating is a reflection of rising and widespread systemic instability and the general financial deterioration of corporate America. I predict that we’ll start to hear more about GE’s collapsing operational and financial condition and we’ll start to see a lot more companies head down the same path as GE.

Note:  The above commentary is an excerpt from the November 18th Short Seller’s Journal.  Since then, GE’s stock price has dropped another 5.5%.  I had recommended shorting GE at $30 in the January 29, 2017 issue of SSJ.  GE’s tangible net worth (book value minus goodwill + intangibles) is negative $31.3 billion.

GE also has a $28.7 billion+ underfunded pension obligation. It is by far the largest underfunded pension in corporate America.  I say “$28.7 billion+” because I’m certain that if an independent auditor plowed through the pension fund assets and liabilities, it would discover that the assets are overstated and the liabilities (future beneficiary payouts) are understated.

In other words, GE’s balance sheet is the equivalent of financial Fukushima.  The previous CEO borrowed $6 billion to cover pension payments through 2020. This is like throwing napalm on a gasoline fire.

The Collateral Grab Begins As Tesla Burns Through Cash

Tesla bank creditors have forced the Company to add its Fremont manufacturing factory to the pool of assets which secure Tesla’s $1.8 billion credit facility. The cover story is that the banks “suggested” that Tesla add the additional collateral to support the asset base underlying the bank. However, that’s unmitigated propaganda.

Banks have access to the inside books at companies to which they lend. In this regard, bank creditors have valuable insight to the actual cash flows in and out of a borrower. Anyone who has dabbled professionally in the world of credit, especially junk credit, will recognize this as the beginning of the end for Tesla. This is a move by the bank lenders to grab title to Tesla’s most valuable assets. Soon there will be a scramble to tie anything not already pledged.

The junk bond investors are totally screwed now. Not that we have any idea of the true “next best use” of Tesla’s primary assets. But by the time the liquidation of Tesla begins there will be a flood of EV’s on the market which means there will likely not be much demand from a company looking to use Tesla’s manufacturing facilities to produce even more EVs. In fact, its seems at this point that Tesla’s production process has major flaws, which means the facilities require a large infusion of capital to bring Tesla’s facility up to an acceptable standard of production quality. They may choose to bring in process engineering expertise or new technology and software from ICE Process Management to bring their facilities up to standard.

Perhaps the next best use in a place like Fremont is to convert the manufacturing facility into a homeless shelter. But that won’t help the banks.

This is to say that, intrinsically, the junk bonds are worth zero. The assets are tied by the banks and likely worth less than that the value of the debt that sits above the junk bonds in the pecking order. The bondholders have no prayer of ever receiving their principal back from cash flow. This means that the stock is intrinsically worth zero as well.

I guess the irony in this situation is that Deutsche Bank, of all banks, is the lead creditor. Talk about letting the inmates run the asylum…this also means, of course, that $10’s of billions in credit default swaps are likely connected to the credit facility as well as the junk bonds. As is, Deutsche Bank is radioactive. Add Tesla to that mix and the recipe for financial nuclear explosion has been created.

Hidden In Plain View / Eyes Wide Shut

The impending economic collapse is hidden from most. People only see a rising stock market, not the negative underlying factors that will cause the whole system to crash. – Peter Schiff

The average middle class household is getting squeezed by an income that is not keeping up with the cost of living. Unfortunately, a major portion of the cost of living has become debt service. Most car buyers assume an almost insane amount of debt to buy a new car. Credit card debt is being used to make ends meet. Low-to-no down payment mortgages have funded most of the homes sold over the last few years. The problem, however, is that the financial system enables this behavior. One has to wonder if this was not intentional…

The quote above is from a recent Peter Schiff podcast. He goes on to say the it’s unclear how quickly the financial system will unravel but “it is close” to happening. I wanted to use that quote because one of the goals of the Short Seller’s Journal is to present hard evidence that brings to your attention the “negative underlying factors” which contradict the “official” narrative about the economy and financial system.

A subscriber of mine sent an article to me in which the Wall Street economist, Joe LaVorgna, was forecasting today’s GDP report to surprise everyone by coming in at 5%. I literally laughed out loud. LaVorgna is a hack who has spent his career on Wall Street preaching fairytales about the economy as a means of assisting the snakeoil salesmen at his bank in their efforts to stuff as much high-commission junk into investor accounts as possible. People like LaVorgna would sell their mother for a small commission. I know this because everyone who was above me in the food-chain in the securities division of Bankers Trust in the 1990’s was like that.

Ultimately the truth will prevail but by then it will be too late. In the meantime, here’s a tell-tale indicator that criminals on Wall Street and at the Fed can’t hide:

The chart above shows the rate of return comparison between the S&P 500 and junk bonds (HYG). Historically going back at least to the 1990’s, stocks tend to move in the same direction as junk bonds on a lagged basis. That lag when I was trading junk bonds was usually anywhere from a couple weeks to a couple months. The massive Central Bank intervention has largely removed the ability of the stock market to perceive fundamental problems developing in the financial and economic system. But the junk bond market is starting to smell problems.

Morgan Stanley’s wealth management division announced right after New Year’s that it was taking its recommended portfolio allocation in junk bonds down to zero. The rationale was that, while tax cut euphoria might inject fresh momentum into “high-flying stocks, the boost may be short-lived and will mask balance sheet weaknesses” – i.e. developing credit problems. The Morgan Stanley report further explained that “credit markets figure this out before equities” and that they are preparing “for a deterioration in lower-quality earnings in the U.S. led by lower operating margins.”

I nearly fell off my chair when I saw this commentary from Morgan Stanley. In my 32 years of active participation in the financial markets I can not recall any brokerage firm ever issuing a stark warning like this about any sector of the financial markets.

At some point the fundamental problems will become too obvious for stocks to ignore and there will be abrupt sell-offs. The 360 point drop from top to bottom last Tuesday was a hint of what’s to come. Eventually the Central Banks will be unable to intervene and manipulate the type of bounce that was engineered at Tuesday’s bottom and that followed-through on Wednesday and beyond.

All of this is going on in plain view. But the sheeple are too worried about whether or not they can take out enough debt to buy the cars and homes required to keep up with everyone else. But “everyone else” is doing the same thing. Default rates are starting to soar on credit card and auto loan debt. This will soon spill over into mortgages. My thesis on the housing market was confirmed by an industry-insider – a point which I will detail for my subscribers this weekend. We’re already seeing signs that the economy hit a wall in December. It will only get worse.

My subscribers who shorted my homebuilder stock idea two weeks ago are now up 17.7%. That’s if they shorted the shares. They are up even more if they used puts. If you are interested in learning how to take advantage of the coming stock market crash, you learn more about the Short Seller’s Journal here:   Short Seller’s Journal information.

Deutsche Bank Is Collapsing – But It’s Not The “Black Swan”

The global financial system is close to going supernova.

Both Credit Suisse and Deutsche Bank stocks are hitting all-time lows.  Both are collapsing despite billions in Central Bank – Fed, ECB, Bundesbank, Swiss National Bank – monetary support.

Deutsche Bank had been advertising a 5% interest rate to customers in Belgium on  90-day deposits of at least 50k euros .  Bank deposits are essentially “loans” to a bank from the depositor (creditor).  This implies that the rate that DB had to pay to attract deposits is equivalent to a triple-C rated credit (although the 10-yr junk bond rates for double-B  rated bonds are around 5.5%, keep in mind that DB is paying 5% for 3-month money).   This is the unmistakable sign of a company that is collapsing.

DB stock was down over 3% yesterday on a day when most big TBTF banks for down 1% or less. It’s down another 2.8% 3% as I write this today, trading below $15/share for the first time ever.   This bank is obviously collapsing and any money manager who holds onto this stock for clients is in serious breach of fiduciary duty.  This is the 2016 version of Enron.

But it won’t be a “Black Swan” event.  The Central Bank authorities knew DB was going to collapse when Anshu Jain was fired in June 2015, literally about  2 weeks after DB’s board had given Jain even more control over bank operations.  However, the Central Banks mentioned above collectively had a year to put a “ring” around the collateral damage – i.e. the derivative counter-party default risks – that occurs from DB collapsing.

The Credit Suisse problems have been far less visible but the behavior of the stock is signalling to us that CS’ problems are on par with DB’s.  I don’t know if both banks will ultimately end up being monetized by a combination of taxpayer bailiouts (including U.S. Taxpayers) and bail-ins.  I would suggest that bail-in capital available would not even remotely address the derivatives-related liabilities embedded in the Credit Suisse’s and DB’s balance  sheets.

My point here is that – unless there’s even bigger problems hidden from the Central Banks, which have had a year now to address the DB/CS situation – a DB collapse will likely cause a sell-off in the stock market, but would not be the “Black Swan” for which everyone is searching.

I don’t know what the Black Swan is or what it will look like.  Otherwise it wouldn’t be a Black Swan, right?  What I will suggest is that the day in which the “box” with Schrodinger’s cat appears and we look into to it to see a dead cat is quickly approaching.  I would also suggest that this is why those who have been calling for a short-term wipe-out in the price of gold have been proved wrong for over two months, despite the blatant daily attempts by the Fed/ECB/bullion banks to push the price of gold lower.

This is a development that no one is talking about – but I believe that is represents a hidden slow-motion financial collapse that will soon accelerate:



The Junk Bond Market Is Collapsing

It’s not just distressed debt or the energy sector.  I was chatting with a friend/colleague in NYC who is connected with the high yield market.  To begin with, the economic devastation to Texas from the collapsing price of oil is just beginning.  Word to him from a big Texas bank is that the massive asset write-downs – i.e. energy and real estate loans – are just starting.  Up until now the banks and financial firms have been able to hold off marking to market in hopes of a recovery in the price of oil.  But distressed offerings in oil, gas and real estate assets are starting to hit the market and it’s going to force the issue. This is going to get ugly.

This is economic fall-out that will spread to the entire country.

Next we turned to the high yield market and he remarked that the junk market is collapsing.  And it’s not just oil bonds – it’s gas, technology, healthcare, industrial, retail – everything. The few recent deals that got done soaked up all the cash available and now big outflows are starting again.  There’s no liquidity and bids that show up within a reasonable context of the quoted bid/ask market get tattoo’d.  It’s impossible to move any kind of stuff – i.e. big investors, mutual funds, pension funds are stuck.

Here’s two graphs that illustrate just how far off the rails the stock market has gone:

UntitledThis graph from The King Report illustrates the current differential between junk bonds and the SPX vs. the differential in August. Recall that in August the S&P 500 plunged 11.2% in six trading sessions

The second graph compares the returns to the HYG I-shares high yield ETF and the S&P 500. As you can see the, divergence between the S&P 500 and the high yield bond market has reached an absurd level. The high yield market, in the absence of extreme intervention, typically will lead the stock marketUntitled1 directionally. This is especially true on the downside because high yield investors typically are “privy” to bank credit information – trust me, this is true, as our high yield desk was next to the bank debt trading desk and we were very friendly with each other – and can see when corporate numbers are deteriorating well in advance of equity analysts and investors.  As you can see from this graph the divergence between high yield debt and the S&P 500 has never been greater.

We can draw two conclusions from the information conveyed in the two graphs above:  1) the Fed is terrified of letting the stock market move lower and, for now at least, has a solid iron floor beneath the stock market;  2)  the credit condition of corporate America has been deteriorating since early 2013, punctuated by 3 quarters in a row of declining earnings for the S&P 500.  Revenues have been flat to down on average for a couple years.


This is not going to end well for anyone.  I would suggest that this is one of the specific reasons that the U.S. Government is ramping up its military aggression, rampant domestic fear-mongering and extreme propaganda.  We can’t even enjoy a college or NFL football game anymore without the shameless promotion of the military constantly thrown in our face.

History tells us – and it is very clear on this matter – when all else fails, collapsing empires start a war.  This war started slowly burning when Bush II attacked Iraq and now it’s escalating into a global conflict.  This will not end well…Happy Thanksgiving.

The whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by menacing it with an endless series of hobgoblins, all of them imaginary.  – HL Menken

Jeff Bezos Is The Poster Child For U.S. Systemic Ponzi Scheme

Forbes released its annual list of wealthiest Americans this week.  The data shows that Jeff Bezos, the founder and CEO of Amazon.com, made $16 billion in 2014.  While perhaps admired by the segment of our society that worships the dollar above all else, this is nothing more than the grotesque reminder how just how fraudulent the United States system has become.

Bezos earned in one year more than 8x the amount of net income that he has delivered to AMZN shareholders cumulatively over the 20-year operating history of the Company:

AMZNnetIncThis is well beyond the bounds of obscenity. It’s criminal. The SEC allows Bezos to get away with semi-fraudulent accounting. It lets him get away with misrepresenting the Company’s “free cash flow” when it makes its quarterly “earnings” report to shareholders.

Jeff Bezos represents the most insidious form of fraud of in this country. He’s far worse than Madoff. Madoff just screwed over his wealthy peers. Bezos is sucking wealth from every nook and cranny in the investment fund world, including and especially the the average middle class mutual fund and every single pension fund invested in AMZN stock.

Amazon’s operations burn cash like a Weimar-era furnace.  The company burned over $4 billion dollars between end of its first quarter in 2015 (end of March) and the end of its second quarter in 2015 (end of June).   The Company had almost no debt at the beginning of 2012 and by the end of 2014 it had $9 billion.  Nearly half of the cash was incinerated during the April – June quarterly period this year.

But it’s not entirely Bezos’ fault.  Ultimately the blame falls on the institutional pools of investment capital and the retail investors who trust their “expert” financial advisors with their money.   The idea of value investing and investing based on fundamentals was exterminated from the system a long time ago.  Almost every single pension fund manager and every single investment advisor in this country would  not know how to engage in serious fundamental investing even if it were required to save their lives.

Of course, we know what Jeff Bezos thinks about all of this:

Short/Sell This Bounce In Glencore Stock AND Short The Bonds

Glencore stock has bounced at 16% today on a rumor that some investment group could take Glencore private.  Too be sure, there’s plenty of idiots out there with enough cash to pay 9x revenues for The Onion’s business section (Business Insider), but it’s another matter to find enough banks and institutional investors investors willing to finance a massive $40-50 billion buyout of an overleveraged commodity company.  This is especially true given that the outlook for Glencore’s base metal products is very grim given that the world is on the cusp on the worst economic depression in history.

The bonds have not moved in response to that rumor, with the Glencore 5.95’s of 2020 trading in the 70’s.  That’s 70 cents on the dollar.  That’s roughly a YTM of 6.44%, or about 500 basis points off the 5-yr Treasury.  That’s the equivalent of a low-B or triple-C rated bond, which reflects a fairly high probability of eventual insolvency.   Furthermore, the cost of credit default risk insurance got more expensive today.   Both of these markets are telling us that, not only was the rumor absurd but that the credit markets are expecting a turn for the worse.

Glencore is now going to conduct a fire sale of assets in order to start addressing its $30 billion in debt.   This is the absolute worst time to sell assets which derive their intrinsic value from base metals, energy and agricultural products.   This is the classic sign of a “fire sale” being conducted by a company that is walking the plank.   It also tells us that the willingness of the credit market – which have behaved like moronic drunken sailors for the last 5 years – is unwilling to chase bad money with more printed money.   

Glencore is entering the irreversible death spiral.   We used call the bonds issued by companies in Glencore’s predicament, “IDS bonds” – irreversible debt spiral bonds.  The only event that will save Glencore is a massive helicopter drop of more printed money and I doubt even that will move the needle on commodity prices (except gold and silver, of course) other than a brief knee-jerk bounce.  QE does not stimulate real economic growth.

Perhaps the best indicator that Glencore is poisonous is the fact that Carl Icahn is not trying to get involved.  In my opinion he sniffs out opportunities to capitalize on bubbling Ponzi schemes better than any investor I’ve observed.  The difference between Carl and the crooks who bought Glencore is that Icahn doesn’t get involved unless he has a “greater fool” in his back pocket.

The Glencore equity holders do not have a greater fool.   I take that back:  the bondholders who financed the original buyout are the greater fools.  And the greatest fools are participants in the pension plans managed by the greater fool institutional investors.

Not only is Carl Icahn not sniffing around Glencore’s back-side, he’s issued a statement today which indicates he’s going to take his chips off the table and find a different game to play.  The greater fools who will pay more than the previous fools are likely gone altogether from this market. But there will plenty of greatest fools who will try to catch falling knives…

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:


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:


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.

Rot Of Empire: Moody’s Downgrades Chicago To Junk Bond Status

I thought junk bonds were ‘high risk – high return’ whereas I’d have thought Chicago was more ‘high risk – no return.   Not so much junk bonds, just junk. Reader comment from  “Mike”

It’s doubtful that Warren Buffet’s Moody’s Investor Services will face the same wrath from Obama that Obama inflicted on S&P after S&P downgraded the U.S. Government debt rating from triple-A to double-A.   After all,  Warren Buffet owns Obama.

The outlook on all long term ratings remains negative (LINK)

But recall that Moody’s did not downgrade Enron to junk status until Enron hit the wall. While I’m not suggesting that Chicago will hit the wall anytime in the next few weeks, it does suggest that the White House is probably evaluating bail-out ideas.

I’m not sure how Obama thinks he can smooth this one by all Federal taxpayers outside of the State of Illinois (which itself is running something like an admitted $21 billion budget deficit).  But, then again, something like 45% of registered Democrats have expressed voting support for a criminal (Hillary Clinton), so anything is possible in this Orwellian paradise.

Here’s a summary of Moody’s downgrade “rationale:”

The Ba1 rating on Chicago’s GO debt incorporates expected growth in the city’s highly elevated unfunded pension liabilities. Based on the Illinois Supreme Court’s May 8 overturning of the statute that governs the State of Illinois’ (A3 negative) pensions, we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably. Whether or not the current statutes that govern Chicago’s pension plans stand, we expect the costs of servicing Chicago’s unfunded liabilities will grow, placing significant strain on the city’s financial operations absent commensurate growth in revenue and/or reductions in other expenditures.

Our negative outlook reflects our expectation that Chicago’s credit challenges will continue, both in the near term and in the long term. Immediate credit challenges include potential draws on liquidity associated with rating triggers embedded in the city’s letters of credit (LOCs), standby bond purchase agreement (SBPA), lines of credit, direct bank loans, and swaps [Oops – banks can and should pull the plug].  The current rating actions give the counterparties of these transactions the option to immediately demand up to $2.2 billion in accelerated principal and accrued interest and associated termination fees.

Chicago, like Detroit before it, is emblematic of the Rot of Empire.  Large industrial-based cities have been gutted by modern day Robber Barons who have moved the bulk of America’s industrial base to cheap-labor eastern hemisphere domains.   These large Rust-Belt metropolitan areas are collapsing under the weight massive budget deficits and catastrophically underfunded public employee pension funds.

I would hazard an educated guess that if Moody’s has determined that Chicago is regarded as below investment grade, the stark reality is that Chicago is likely on the verge of collapse barring some likely smoke-filled back room deals cut between Obama and his former puppet-master, Rahm Emanuel (Mayor of Chicago).

I would bet that the United States is entering it’s Final Chapter.  This is why the Obama regime has intensified its attempt at global military control both domestically (Jade Helm) and abroad.

I hope I’m wrong, but I have a bad feeling that life is going to become very uncomfortable for anyone not a member of highest elitist echelon.  This would mean everyone except those in the “three-comma club” (billionaires) and the political puppets controlled by the ultra-wealthy.

Junk Bonds Are Setting Up To Destroy Investor Wealth

“Pigs are greedy and hogs get slaughtered.”

When I was a junk bond trader in the 1990s’ we referred to anyone who bought a bond yielding over 12% as “a yield hog.” Back then, anything over 12% had a high probability of default. Back then 12% was 600 basis points (6%) over the 10-yr Treasury bond.

Currently, some junk bonds with triple-C ratings are yielding under 6%. This is less than 400 basis points (4%) over the the 10-yr bond. Think about it: because the Fed has taken short rates to zero, investors are chasing bonds with 5% yields that have at least a 50/50 chance of defaulting. This is despite the fact that energy junk bonds recently have delivered $100’s of millions of losses to junk bond investors.

The retail investor is always the last one in when chasing an investment bubble and always gets hurt the most when the bubble collapses. Currently there’s a massive bubble being blown in the junk bond market.

An article published by Bloomberg – LINK – this morning started off with a rather improbable assertion: “The new fixed-income haven is, of all things, the market for junk bonds.” As a former junk bond trader this got my attention.

The Merriam-Webster dictionary defines the word “haven” as “a place where you are protected from danger, trouble, etc.” Referencing junk bonds as a place where investors “are protected from danger” is the epitome of theatrical absurdity. I doubt Henrik Ibsen could have written anything as grotesquely obtuse.

High-yield bonds represent “some of the best strategies to generate total return in today’s low-return environment,” said Payson Swaffield, the London-based chief investment officer for fixed income at Eaton Vance Investment Managers, which oversees $300 billion. from the Bloomberg article linked above.

Anyone invested in Eaton Vance high yield funds should head for the exits immediately. Generating “total return” is not necessarily the best investment strategy, especially when you add in the risk of not having your money returned at all. Mr. Swaffield has described the “yield hog” chasing strategy that we used to laugh at when I was a junk bond market professional. We laughed because we made a lot of money selling those bonds to people like Mr. Swaffield and we knew they were going to get hammered eventually.

The Central Banks are at the root of this impending tragic investment bubble. ZIRP and NIRP policies are forcing investors out of cash and near-zero or negative yielding “havens” and into slightly higher yielding investments in which the potential rate of return does not even remotely reflect the degree of risk being taken. In other words, current monetary policy has completely removed the concept of “risk evaluation” from the market.

The risk in higher yielding junk bonds first and foremost is derived from fact that any company paying north of 5% to issue debt has a high probability of never paying back the investors who by the debt. Again, I reference the recent collapse of energy junk bonds.

The second source of risk is liquidity risk. NO ONE is considering this risk. Liquidity risk derived from an investors ability to sell an investment when the market is dropping. The junk bond market is notorious for going “illiquid” at times when investors need bid-side liquidity the most. I’ve seen a big seller who needed to sell a big position in a junk bond issue force the market down 40 points in order find a level where buyers would step up.

Now that’s liquidity risk. The current yield on all fixed income securities – and specifically the general yield of the junk market – does not in any way price in liquidity risk (aka a “liquidity premium”).

“It’s very tricky” for insurers, said Bruce Porteous, an investment director for insurance solutions at Standard Life Investments, which oversees about $370 billion. They’re making a shift because “they can’t earn enough money on the assets they hold to provide the benefits that they offer.” – Bloomberg

That statement by Mr. Porteous is just a politically and socially correct way for saying that insurance companies are being forced into junk bonds because they are currently underfunded in relation to their expected future insurance claim payouts – i.e. insurance companies have a negative net worth. So the solution is to become a junk bond yield hog.

If insurance companies and pension funds are underfunded currently, just wait until the junk bond market goes through another cyclical collapse…


The graph above (source: The Aleph Blog, edits in red are mine) shows what happened to junk bonds during the tech crash in 2000 and the Great Financial Collapse in 2008. The graph only goes through Dec 2012. If it extended to today, the purple line – which represents the Merrill Lynch High Yield Master 2 Trust – would be a bit below 5%. I would suggest that when the current stock bubble pops, the two areas in red circles above will look like small blips in comparison to the carnage that is in store for the junk bond market.

The Fed and the other western Central Banks have imposed this extreme moral hazard on the market in what is being termed as “attempt to prevent deflation.” However, I would also suggest that it is just another massive wealth transfer mechanism being used by the elitists to fleece the public.

Wall Street makes $100’s of millions underwriting junk bonds and selling them to the public. Junk bonds are typically subordinated, unsecured debt obligations of the issuer. It means that if you own the junk bonds of a company that goes bankrupt, you get to stand in line behind all of the senior secured and senior unsecured claimants before you see a dime. This includes specifically holders of derivatives, who get to stand at the front of the line courtesy of the Obama administration. If you have a retirement fund or an insurance policy, you are exposed to the junk bond market.

When I was a junk bond trader in the 1990’s, high yield money would be pulled from the market abruptly and quickly, usually about a week before the stock market would undergo a big sell-off. With the current capital markets having been flooded with Fed, Bank of Japan and ECB money printing, I’m not sure the junk bond market will act as a warning beacon this time around.

In fact, I would bet good money that junk bond investors will wake up one day and find that the value of their holdings will be down 40-50% overnight. And that’s just for starters. Wait until the herd of insurance companies and pension managers try to unload their holdings.

This is yet another Fed engineered bubble that accomplishes the massive transfer of wealth from the public to Wall Street and that will end very badly for investors, especially retail investors.

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