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Signs Of A 2020 Top: “Buyers Return to Riskiest Junk Bonds”

If you’re managing money and need positive results in the year ahead, you’re in a tough spot. Stocks are at levels that in the past have preceded cycle-ending crashes while high-grade bonds yield virtually nothing but could easily produce big capital losses if interest rates rise even a little.

What do you do? Retire, if you care about your health. But if you choose to stay in the business, you’ll have to move waaayyy out on the risk spectrum. In fixed income, that means not just junk, but extreme junk. From this week’s Wall Street Journal:

Buyers Return to Riskiest Junk Bonds

Bonds with the lowest junk credit ratings have rallied in December, rebounding from a beating taken this fall, as fund managers prepare for 2020 by adding risk to their portfolios.

The junk-bond bounce comes as optimism about global growth and easing trade tensions stokes investor appetite for other risky assets such as copper.

“People are looking at their funds and thinking ‘what can generate performance next year?’” said Eric Hess, credit analyst at mutual-fund manager Newfleet Asset Management. With higher quality bonds trading near record highs, investors are dipping back into the riskiest patch of high yield, he said.

Bonds rated triple-C—one of the lowest ratings rungs in the below-investment-grade category—returned 4.7% this month through Dec. 23 counting price changes and interest payments, according to data from Bloomberg Barclays Indices. The rebound erased the 3.2% loss triple-C bonds posted from August to November, when fears of rising defaults prompted investors to dump riskier debt and buy the safest high-yield bonds rated double-B.

The flight to safety this autumn helped double-B bonds gain about 14.6% this year through Dec. 23, pushing yields of the safer debt to a near-record low of 3.5% from around 6.2% at the end of 2018, according to data from Bloomberg Barclays. The yields bonds pay investors drop when prices rise.

At such tight yields, double-B bonds are far less likely to outperform next year, analysts said.

“We don’t like them because there is nothing left there in terms of upside potential,” said Oleg Melentyev, high-yield strategist at Bank of America Corp. “The only pocket of opportunity left is in lower quality names.”

There’s just one little problem. In the following Bloomberg interview, economist David Rosenberg explains that record high corporate borrowing isn’t generating more capital spending; it’s just producing more leverage.

Think this through for a minute: Continued economic growth requires more credit creation, but only the riskiest sectors of the economy feature bonds that are attractive to investors. The result: The weakest companies raise the most debt, and the financial system gets riskier without producing the wealth that’s necessary to offset the mounting risks.

2020, in short, is looking like a typical end-of-cycle year, just waiting for a pin to pop the bubble.

 

Emigrate While You Still Can – To Finca Bayano

5 thoughts on "Signs Of A 2020 Top: “Buyers Return to Riskiest Junk Bonds”"

  1. You can almost always depend on getting a bearish quote from Rosenberg. He is right about basic economy theory but wrong more of the time in terms of where the market is going. At some point we will get a downturn because of debt crisis, but he has been way to early way too long. He may be right about the fourth quarter but I would not be surprised the market holds until Trump is re-elected.

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  2. “Continued economic growth requires more credit creation.”

    Either I don’t understand that or I’m not sure it’s true. It seems to me that means economic growth is really just a mirage. It’s like one’s life savings are possible only if it’s based on debt, that it is only borrowed. If the corollary is true, that credit destruction requires economic contraction then surely a mirage it all is. But even if it is a mirage it’s a very real one because real products and services can be both bought and produced using borrowed “money. ”

    The idea that all debts must be repaid may be wrong too – or at least not so rigid. The traditional loan arrangement involves the ultimate return of the borrowed amount, plus interest. But it seems to be increasingly clear that borrowed principle will never be repaid on a large scale, but only interest paid ad infinitum. If so, then there may not be a limit to debt levels because ever higher debt (“lending”) begets ever higher income, income that would not exist if the money weren’t lent.

    It may be erroneous to believe that all money must be invested – or made to make more – but as long as it is ever greater amounts of lending to create income becomes necessary.

    Imagine lending money to an entity that has unlimited access to more credit. You might ask why such an entity would borrow from you at all, but you could say that it has to borrow from someone, so why not you. It’s like having a business. Every customer could go elsewhere but you get your share. In any case, the reality of risk is nonexistent. Things could be so upside down now that the more ‘risky” lending the less risky it becomes. If the junk bond market becomes big enough wouldn’t it then be more likely to be protected and backed by the central banks to avoid contagion? Traditionally only government debt had that protection but the CBs have shown they will back anything to avoid problems. And the more investors figure that out the LOWER junk bond interest rates will go, to reflect the ever decreasing risk of bankruptcy or default.

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