A Frightening Fact About the Bond Market
A frightening fact about the bond market... Half of U.S. investment-grade debt is little better than junk... The latest on the correction... A bullish sign from one of Sjug's favorite indicators...
Regular Digest readers know we expect the coming credit-default cycle to be one for the record books...
The reason is simple: We've never experienced a bigger debt-fueled boom than the one we've witnessed over the past 10 years.
The world's major economies have never been this overleveraged before. And there may be no clearer example of these excesses than the U.S. corporate bond market. As the Wall Street Journal reported this morning, even many supposedly "safe" investment-grade bonds are far riskier than many investors likely realize...
U.S. companies have been bulking up on debt, introducing another wild card into financial markets already rattled by the recent tech selloff and the prospect of rising interest rates.
One slice of the high-grade corporate bond universe is fast becoming the epicenter of these concerns. There is $2.5 trillion in outstanding U.S. debt rated triple-B, according to Morgan Stanley, up from $1.3 trillion five years ago and $686 billion a decade ago.
That is the most ever for companies rated triple-B, which is the lowest rung of the ratings ladder for companies that are above more speculative, or junk, bonds.
The following chart puts this mind-boggling trend in perspective...
Despite its current rating, about half of today's 'safe' corporate debt is just a single downgrade from junk...
Again, this should sound familiar to regular readers. We've been warning you about these issues for months. As Porter noted most recently in the March 23 Digest...
American corporations have never carried so much debt (relative to GDP) before... and the overall quality of this credit has never been lower...
The size of the BBB-rated corporate debt market (one notch above "junk") is now twice the size of the entire high-yield market. That is, most American businesses that have issued bonds are either already a "junk" credit risk, or are within one downgrade of becoming so.
Trust me when I tell you that the next default cycle we have in this country will be the most devastating financial crisis in our history, far worse than the events of 2008/2009.
Of course, as we often say, 'inevitable' doesn't necessarily mean 'imminent'...
Today, yields on even the "junkiest" corporate debt remain low. Default rates are slowly ticking higher, but they, too, remain historically low. For now, we don't see many signs of stress in the credit markets.
Likewise, while we expect to see "lower lows" in U.S. stocks in the near term, we believe the bull market is likely to continue awhile longer as well. As we explained last Wednesday...
Virtually every major bear market over the past 100 years has coincided with fundamental weakness in the economy. This was the case during the Great Depression, the big inflationary bear market of the 1970s, the dot-com bust of the early 2000s, and the financial crisis of 2008/2009.
However, when the market has plunged – or even crashed – without these corresponding economic troubles, the market typically rebounded quickly.
As we noted, the huge "Black Monday" crash of October 19, 1987 is the classic example...
U.S. markets crashed more than 20% that day, while many markets around the globe plunged even further. It became the largest one-day decline in history.
If you were in the markets at that time, you may recall that practically everyone in the financial media was predicting the start of another vicious multiyear bear market like the one that had just ended in 1982. Many were predicting a second Great Depression.
In reality, the economy was just fine. Stocks would bottom the next day and the bull market would resume almost immediately. Anyone bold enough to buy during the panic made a fortune over the next several years.
For now, the economy remains strong. This suggests the recent correction is merely a pullback in an ongoing bull market, rather than the start of a new bear market.
But that isn't the only reason for optimism...
We also note that one of Steve Sjuggerud's favorite market "vital signs" – the advance/decline line – is sending a bullish signal today.
Regular readers may recall the advance/decline line is a measure of market "breadth." It compares how many stocks in the market are rising versus how many are falling each day. When more stocks are rising than falling, the advance/decline line rises, and vice versa.
As Steve has explained, this indicator has been a powerful "early warning" signal ahead of major bear markets in the past.
For example, during the last "Melt Up" in the late 1990s, the advance/decline line peaked in 1998, nearly two years before the stock market finally topped. This "negative divergence" was a sign that the market was being pulled higher by fewer and fewer stocks, which is not what you see in a healthy bull market.
A similar scenario played out before the financial crisis in 2007. The advance/decline line peaked nearly six months before the broad market. Again, fewer and fewer stocks were leading the market higher. The market's vitals were growing weaker.
Today, that is not the case...
As you can see in the following chart, the advance/decline line has continued to move in tandem with stocks. Both moved higher through most of the past year. Both peaked in late January. And both moved lower in February...
But you can also see that the advance/decline line has held up better than stocks over the past couple months. It fell less than the broad market in February, rebounded higher in March, and has fallen less as stocks have moved lower again.
This "positive divergence" is a bullish sign. It, too, suggests the pullback is simply a correction in an ongoing bull market, rather than the start of a more serious decline.
Our advice remains the same...
Stay long, but make sure you're properly managing risk.
Are you holding a reasonably diversified portfolio?
Have you "hedged" your long positions with some extra cash, a little "portfolio insurance" in the form of precious metals, and perhaps a few short sales?
Are you using intelligent position sizing?
And do you have a trailing-stop loss (or another clear exit strategy) for every position you own?
If you can't confidently answer yes to each of these questions, we urge you to take a little time to change that immediately.
New 52-week highs (as of 3/29/18): none.
The feedback on the "Porter vs. David A." debate continues to roll in. As always, send your questions, comments, and concerns to feedback@stansberryresearch.com.
"This was one of Porter's most eloquent responses ever and stopped me in my tracks. I have had many similar discussions with my brother, who represents the David A. perspective. Despite countless examples throughout history of how uncontrolled governments eventually suppress the citizenry in the pursuit of ever more government power, some people still feel the answer to every problem is more government.
"I shared Porter's response with my wife, and we both felt Porter was speaking to us, and for us. What a great expression of individual freedom, liberty, and true capitalism (rather than crony capitalism). Porter, keep up the great work. And the great commentary!" – Paid-up subscriber Steven B.
"It is a mystery why so many people are compelled to criticize without reading or understanding what a writer or speaker has said. Porter is right most of the time and when he is not right he takes responsibility for his error. I stand with Porter! David A. should have listened to Mark Twain who said, 'it is better to remain silent and be thought a fool than to speak and remove all doubt.'"- Paid-up subscriber John W.
"Porter, really appreciated your Friday Digest. Like George Orwell in Britain during World War II and Thomas Paine during the Revolution, you are one of today's voices of reason for the people. Rather than understanding that the idea of America is that everyone should have the same opportunities to raise their station or quality of life, people nowadays choose to believe they are entitled to the same opportunities PLUS entitled to the same results as everyone else (regardless of effort). Lovely." – Paid-up subscriber Steve S.
"I inadvertently deleted the Digest that had Porter's response to David A. which I see is highly praised. Unfortunately, I also deleted my trash folder so I cannot recover here. Any help would be greatly appreciated." – Paid-up subscriber Jim
Brill comment: Jim, you can find Porter's response in the March 27 Digest mailbag right here.
Regards,
Justin Brill
Baltimore, Maryland
April 2, 2018