Junk Bond Spreads Widen on Sovereign Debt Concerns
A: Yes global market forces and sovereign debt concerns do matter. They just matter before any ripple may ultimately come our way, so its worth keeping your eyes on. After the huge rally in all assets for much of 2009, the search for yield now comes with great risk and you are seeing signs of risk aversion these past few weeks. Will the equity markets once again lag and follow the credit markets?
According to FT's, "Investors Abandon Junk Bonds" (via Yves over at NakedCapitalism):
Spreads – the difference between the yields on junk bonds and US Treasuries – have widened more than 100 basis points since January 11, and stand at about 700bp, as measured by the Bank of America Merrill Lynch index.Below you can see the latest MARKIT CDX.NA.HY INDEX, Series 13, showing the recent rise in spreads the past 4 weeks or so:
“If the result of sovereign problems is fiscal tightening and higher rates, a double-dip recession becomes an increasing possibility. This outcome would dent, if not fully derail, the positive trend in corporate fundamentals.”
Junk bonds, issued by companies with credit ratings below investment grade, soared in price last year as investors poured more than $30bn into bond funds, in search of higher returns at a time when official interest rates were at all-time lows. This demand for higher yields led to record bond issuance, allowing even cash-strapped companies to refinance. However, in the past week, US high-yield bond funds and exchange-traded funds saw outflows of $984m – the highest since the week of September 28 2005, according to Lipper. The redemptions pushed the trailing four-week average sales figure to an outflow for the first time since March. The net asset value of bond funds tracked by Lipper fell $1.6bn in the week, because of market declines, the largest such drop since November 2008 in the thick of the downturn.
Junk bonds soared in 2009 (reuters states HY bonds soared a record 57.5% in 2009) as the search for yield was the name of the game. Now, after that huge move the search for yield comes with a high price: higher risk, as investors demand higher yield to own junk bonds rather than risk free US Treasurys of similar maturity. As market junkies know all too well, investors hate uncertainty and risk.
Sovereign debt issues & tightening in China now seem to be at the forefront of investor concerns, causing a flight to safer assets (mainly treasuries and US dollars) and that is causing a ripple effect to start an unwind of a huge dollar carry trade that built up for much of 2009 behind Fed ZIRP and guarantees on everything and anything. The buildup of such a crowded trade usually leads to an exaggerated unwind when confidence and perception changes; the challenge is timing and pinpointing the exact spark as you never know what the market will deem worthy of reversing the trade and not. For example, Dubai's default was all but a case of fleas that markets quickly shook off. Greece and other concerns over the PIGS, however, are a different story today. It's still a bit too early to tell if this is simply a healthy adjustment after a huge move in 2009 or something else that will lead to a more extreme adjustment in global markets; either way, our eyes should be open!
As I said before, its possible a future double dip is the result of fiscal/monetary tightening as an unintended consequence of actions taken to stem the crisis we just went through...China began already, time will tell when we do the same.
Posted by mh23
Mon Feb 15th, 2010 01:29 PM
UD:
I have been watching this as well as the one month libor which has also been creeping up over the past week. The Fed will do everything it can to keep the stock market rally going for the obvious reason that a crash will have major consequences for pensions, annuities, "wealth effect" etc.
However, at some point in time the market will reflect what I believe to be reality which is that this is definitely not a V-shaped recovery. I am still long EUO, and I have on a few short positions, which I think I will sell and stay in cash or maybe just look to short the SPY rather than stock picking, at the appropriate time. I have also been watching GLD. While I currently don't own any, if it rises with the dollar as the Euro fiasco plays out, I might consider looking to buy some. However, in the short term things seem to be shaping up well for the dollar, bad for the Euro, and potentially bad for the risk/reflation/dollar carry trade.
Posted by Noah
Tue Feb 16th, 2010 09:46 AM
yes, things certainly SEEM to be favoring the dollar against a currency like the EURO these days...as for he fed, Im not so sure they care much about the stock market, although I know many out there think thats the case..rather, they are focused on the solutions that fixed the credit markets and brought stability to financial system and those policies were clear and will be in place for a while - something the street can make a huge dime off - so I think stocks are really just a proxy for everything for much of 2009, resulting from fed policy and guarantees..
It will be interesting to see what the fed does if bond auctions start failing, or if corporate credit blows out again, or if a huge dollar rally in some way screws up the bank recap environment they want in place for god knows how long.
all this crap is making my head spin! Luckily, I have very minor positions and really havent traded in a long time - all my time goes to development of new site, its so damn tedious. As for gold, that was one trade I did right, selling most of my etfs and calls around 1170 or so..i do have a few long dated calls, but was hoping for a steeper decline to reload. Im still going to wait. Thanks for comment mh23!
Posted by anonymous
Tue Feb 16th, 2010 10:14 AM
It will be interesting how this correction will play out for Wall Street. The junk bond rally and stock market rally are a large part of what drove 2009 bonuses. Last year was an easy year to be a trader. I wonder how well banks that rely on trading will do this year.
Posted by In Debt We Trust
Tue Feb 16th, 2010 06:12 PM
This is a great post. I don't even really look at technical analysis anymore - just examine the CDS spreads to determine market sentiment.
E.g. go long by buying stock futures when spreads widen to extremes and keep close stops.
I would also suggest looking at sovereign PIIGS bond yields vs German govt debt. I can't remember the Bloomberg symbols and have been relying on the Financial Times web page (which is good but not as good as real time). Do you happen to know those symbols?
Posted by Sam
Wed Feb 17th, 2010 10:05 AM
Obviously Sovereign debt should get hit but its interesting that it affects High Yield. How do you figure that there is a disconnect between CDS and equity since the quity market was down a lot in the same time frame?
Posted by Noah
Wed Feb 17th, 2010 08:24 PM
test test test
Posted by coach handbags
Thu Aug 12th, 2010 09:53 PM
It's still a bit too early to tell if this is simply a healthy adjustment after a huge move in 2009 or something else that will lead to a more extreme adjustment in global markets; either way, our eyes should be open!