Junk Bonds Are Sending a Message
Yellen sounds the alarm... Don't bet on a Fed 'rescue' today... Junk bonds are sending a message... What to do if you missed last night's '
Former Federal Reserve Chair Janet Yellen is worried...
She's seeing significant and growing risks in the corporate credit markets. In particular, she said the U.S. needs to address the "huge deterioration" in lending standards in the $1.3 trillion leveraged loan market. As the Financial Times reported yesterday...
"I am worried about the systemic risks associated with these loans," said the former central banker. "There has been a huge deterioration in standards; covenants have been loosened in leveraged lending."
There was a risk lessons from the crash were being forgotten... Ms. Yellen told the FT... "You are supposed to realize from the crisis, it is not just a question of what banks do that imperils themselves, it is what they do that can create risks to the entire financial system. That lesson to me seems to have been lost."
She added: "If we have a downturn in the economy, there are a lot of firms that will go bankrupt, I think, because of this debt. It would probably worsen a downturn."
This should sound familiar to regular Digest readers...
We've been highlighting the slowly but steadily growing excesses in the credit markets for the past several years.
But that's where our agreement with the ex-Fed
There are a couple of problems with this argument...
First, these risks were rising long before the recent deregulatory efforts began. Second, and more important, Yellen conveniently "forgot" to mention the critical role her own policies have played in this mess.
In reality, the absurd extremes we've been seeing in the credit markets simply wouldn't have been possible without years and years of near-zero-percent interest rates and quantitative easing.
But hey, why let the facts get in the way of a good story?
Speaking of the Fed...
Regular readers may also recall we mentioned the so-called "Greenspan Put" last month. As we wrote in the September 27 Digest...
The term was coined in early 2000 for then-Federal Reserve Chairman Alan Greenspan's tendency to cut interest rates at the first sign of financial market turmoil. Like an equity put option that can insure or "hedge" against a stock's decline, investors began to believe the Greenspan Fed would intervene in the markets to minimize any downside.
It has since become known more generally as the "Fed put," as Greenspan's successors have followed his lead. Ben Bernanke, of course, was responsible for slashing interest rates to 0%, and unleashing three rounds of quantitative easing, in response to the 2008 financial crisis. More recently, Janet Yellen unexpectedly halted the Fed's rate-hike cycle in early 2016 following the big stock market correction the previous winter.
Today, most folks naturally assume that [current Fed Chair Jerome] Powell will continue this tradition. When the market inevitably suffers its next big correction, the Fed will halt its rate hike cycle... and possibly even begin to cut rates again.
After all, it has been the Fed's "modus operandi" for 30 years.
However, as we noted at the time, that may not be the case...
The Fed's behavior since Powell took over in February – as well as recent comments from the chair himself – suggests that it could require a legitimate market or economic threat for the central bank to alter its rate hike plan.
In other words, unlike his predecessors, who reacted to every 10%-15% decline in the market, evidence suggests Powell may be inclined to let corrections play out on their own. And comments this morning from Powell's new vice chair, Richard Clarida, added further support to this argument. As Bloomberg reported...
The Federal Reserve's newly installed No. 2 official backed the U.S. central bank's plans for some further gradual interest-rate increases and suggested policy makers won't change course in response to political pressure or recent stock market jitters.
With the Fed "as near as it has been in a decade" to its goals of full employment and price stability, and monetary policy still bolstering the economy, "I believe some further gradual adjustment in the policy rate range will likely be appropriate," Vice Chairman Richard Clarida said Thursday in a speech at the Peterson Institute for International Economics.
Asked whether President Donald Trump's criticism of the Fed's tightening will sway policy decisions, Clarida said "it will in no way be a consideration as far as I'm concerned. We have a very clear mandate" and "our job is to sustain what is a very healthy and robust economy."
Now, there's no telling what the Fed might do in the future...
But we think it would be foolish not to take Powell at his word until he proves otherwise. This is one of the reasons we continue to believe this correction could have further to run in the near term.
The market has historically experienced a 15%-20% pullback every two or three years on average. We're long overdue.
But again, this would not necessarily mean that the long bull market was over.
As you've probably grown tired of hearing lately, all the most reliable long-term indicators we follow tell us the risk of a true bear market or economic recession remain low today.
For example, several of these indicators are related to the credit markets...
Porter reviewed three of the most important in the September 21 Digest...
- The prices of junk bonds. As credit tightens, the prices of junk bonds will fall. You can watch junk-bond funds – like the iShares iBoxx High Yield Corporate Bond Fund (HYG) – to monitor these prices.
- The interest-rate "spread" between high-yield debt and U.S. Treasury securities. As defaults grow, the increased risk will be expressed in much higher interest rates for weak borrowers.
- The 10-year U.S. Treasury yield. If safe yields on government bonds reach 4% or more, the corporate-bond market will experience complete carnage. Average rates to refinance outstanding debts will probably double.
The yield on 10-year Treasury notes has been rising lately, yet it remains well below 4% today. Likewise, spreads between high-yield debt and U.S. Treasurys remain near all-time lows. And as a separate Bloomberg report noted yesterday, high-yield bond prices have remained remarkably stable during the recent sell-off...
While the S&P 500 Total Return Index is down about 6% this month, the sell-off in the riskiest corner of the cash bond market is mild – in contrast to the February correction across risk assets.
Junk bonds have fallen by just 1.26%, while the sector acutely vulnerable to the trajectory of the U.S. economy and tighter financial conditions – debt rated CCC – has dipped by a similar clip.
"High yield is not confirming the downside move in equities and high yield is usually right," Tom Lee, head of research at Fundstrat Global Advisors, wrote in a note. "Macro developments impacting equities also impact high yield – for instance, late-cycle fears would hit both as would earnings-per-share-risk from trade tensions."
The following chart puts these moves in perspective...
As you can see, junk bonds suffered serious declines along with stocks during the 2008-2009 financial crisis, as well as during the broad market correction in late 2015... Yet they've barely budged this year.
In short, junk bonds say it's still too early to worry about the end of this long bull market.
Of course, Steve Sjuggerud covered plenty more reasons to remain bullish during our special 'Melt Up' event last night...
Tens of thousands of folks tuned in to hear Steve share the very latest on his Melt Up thesis, including exactly why he believes this latest correction is no reason to worry.
If you weren't able to join us, we have some good news... Because some folks experienced some technical difficulties (see the mailbag below), we've decided to offer a replay of the event for a limited time. Click here to watch it now.
New 52-week highs (as of 10/24/18): none.
In today's mailbag, a longtime subscriber shares some early feedback on last night's big Melt Up event. What did you think? Please let us know at feedback@stansberryresearch.com.
"Good evening, [Tuesday] night I got about 3 1/2 hours of sleep. When I got home [last night] from work, I told my daughter that I was going to take a nap before the webinar started, and I asked her to wake me up at 6:30 p.m. Central Standard Time. I laid down on the living room sofa at 5:30 p.m. Central Standard Time and promptly fell into a deep sleep. I awoke at 7:01 p.m. Central Standard Time, and my daughter was nowhere to be seen, and the house was dark. I quickly grabbed my laptop and logged in. I was afraid that I wouldn't be able to watch because it had already started. Thankfully, that was not the case.
"My wife came home from work while I was watching. Toward the end, I HAD to go to the bathroom and couldn't wait any longer. I begged her to listen for me while I was gone so I wouldn't lose the name of tonight's 'freebie' if Steve revealed it while I was gone. Sure enough, I was gone about two minutes, and he gave out the stock's name and ticker symbol. My wife did her part and took down the information. What a blessing she is to me.
"Thanks for the show tonight. I know that you guys did a lot of selling, but I thought that it was a fair exchange of my time for your insight. Sincerely." – Paid-up subscriber Jeff K.
"Hi folks, I tried to watch the
"Hello, I am very upset about missing the
"I'm very disappointed! I was all set to hear and see the
"That's the first time this has happened to me. I've watched many webinars, so I don't know what went wrong..." – Paid-up subscriber Lois P.
Brill comment: We're pleased to report that last night's event – which was by far the biggest in Stansberry Research history – went off without a hitch for most readers. However, we did hear from a small number of folks who experienced technical difficulties or where otherwise unable to tune in.
We apologize for any inconvenience. If you were among those who missed last night's presentation, you can access a replay for a short time right here.
Regards,
Justin Brill
Baltimore, Maryland
October 25, 2018