Better check what's in your mutual funds. How are these fund managers getting yield if 13 trillion of sovereign debt now has negative
yields?
http://dimartinobooth.com/bond-market-beware-junkyard-dogs/
" “At this point, we have little doubt that our original forecast of a 4% ex-commodity HY default rate will be met by late 2016/early 2017. Moreover, we think there are now enough reasons to believe that defaults could rise to 5%, ex-commodities, sometime over the next year or so. Coupled with our 20% commodity HY default rate forecast, we are looking at 7.25% aggregate default rate sometime around mid-2017.”
In the event you’ve fallen off Planet Earth in recent weeks, the global corporate default count, as in companies reneging on their promises to make good on those coupon payments, is at the highest level since 2009. And if your memory’s eye has erased 2009 to prevent permanent scarring, the economy was in a full meltdown state back then.
Let’s get this straight. Defaults are going through the roof and investors are flocking to the sector in record numbers? And how.
Moody’s Tiina Siilaberg keeps an eagle’s eye on the concessions investors give to issuers in the form of protections they
don’t demand. They’re called ‘covenants,’ which Investopedia defines as, “designed to protect the interests of both parties. Restrictive covenants forbid the issuer from undertaking certain activities; positive covenants require the issuer to meet specific requirements.”
By Siilaberg’s latest tally, covenant protections are at their weakest level in recorded history. To translate, investors’ collective interests are as vulnerable as they’ve ever been. Though the leveraged loan market remains open for business, Siilaberg is apprehensive about what’s just over the horizon given stretched valuations.
“Issuance in the high yield bond market is still relatively weak compared to historic levels,” Siilaberg said. “I worry, though, because refinancing risk for many lower-rated issuers is close to an all-time high.”
The culprit? That would be a delusional reliance on what Melentyev refers to as, “the new narrative,” and “its apparent reliance on (a) strong monetary response.” Unconventional monetary policy is delivering, “little tangible benefit.”
Overreaching central bankers are in fact doing more harm than good at this juncture. Though small investors may not be wise to the damage being wrought, veterans of financial market warfare are weary to the point of exhaustion.
The endless waiting for Godot has apparently worn their resolve down to near nothing…with good reason. For all of central bankers’ Herculean efforts, expectations that U.S. job losses will accelerate are at a two-year high while households’ prospects for the economy over the next year have fallen to a two-year low.
Pride will surely precede the fall of the orthodoxy of today’s accepted monetary policy framework. But at what cost?
“Everyone in the world needs yield and nothing else matters,” Melentyev laments. “This has never ended in any sort of a problem before, so we can all go back to sleep.” And what happens when we’re abruptly shaken from our slumber?
Recognizing the painfully obvious, Voya’s Cavanaugh observed, “This isn’t a really normal environment.” "
http://www.salientpartners.com/epsilon-theory/when-narratives-go-bad/
"First, little of the increased corporate or government borrowing trickled down into jobs or wage income growth. We’ve all seen the charts. Real wage growth is nonexistent in the Western world. Second, to make it feasible for corporations and governments to borrow these trillions of dollars in the first place, every bit of Central Bank balance sheet expansion (buying bonds) and balance sheet “twist” (buying longer duration bonds) and expansion of allowable securities for purchase (buying more kinds of bonds) and imposition of negative rates (charging
you interest if
youdon’t buy longish-term bonds) was designed to – you guessed it – buy more bonds and thus drive up bond prices and drive down interest rates, particularly longish-term bond prices and longish-term interest rates. That’s great if you’re an investor looking for a percentage return on your bond portfolio.
That’s terrible, however, if you’re an investor looking for an income from your bond portfolio. Over the past seven years, Central Banks have rewarded the return-seeking bond buyer many times over, and they’ve done nothing but punish the income-seeking bond buyer.
Put these two income squelchers together – zero wage income growth because corporations aren’t investing for growth and less-than-zero investment incomegrowth because Central Banks have crushed rates – and you have a vast swath of the voting public in every developed nation on Earth that (rightfully!) feels aggrieved and left behind by the gleaming economic recovery that the status quo Narrative Missionaries tout at every turn. Notably, the failure of wage income growth skews younger and Democrat/left. The failure of investment income growth skews older and Republican/right. The status quo Narratives could survive (and have many times) an assault from one wing of the electorate or the other. But from both simultaneously? It’s going to be a close call.
But here’s the even larger problem lurking in the not-so distant future, and it’s found in the behavioral
WHY of return-seeking bond buyers versus income-seeking bond buyers.
These are two entirely different investor populations from a behavioral perspective, with different languages and different investment genotypes. When I hear an investor or financial advisor ask, “Why in the world would I buy a Swiss bond with a -0.5% interest rate?” I know that I’m talking to an income-seeking bond buyer. The return-seeking bond buyer, on the other hand, says “Hey, if you’re right about the world, those Swiss bonds currently yielding -0.5% are going to -1.0%, which means that the price is going up. Where can I buy one of those?”
The only rational owner of a negative rate bond is a pure return seeker; there arezero income seekers holding negative rate bonds. Why is this a problem? Because income seekers will continue to own bonds even if the price goes down (for a while, anyway; at the very least, they are sticky owners). Return seekers, on the other hand, are not sticky owners at all. They will only own a bond if they think that the price is going up – meaning in this case that yields will continue to become even more negative, i.e., that there’s a greater fool (probably in the form of a Central Bank) willing to pay higher and higher prices for these income-destroying bonds – and they will sell in a heartbeat if they think this dynamic is changing.
There is, to cop a phrase from the People’s Bank of China, a massive “one-way bet” on negative rate sovereign debt today. The momentum trade has crystallized to perfection in negative rate bonds, which has grown to become a $10+ trillion (yes, that’s trillion with a T) asset class.
I think it’s the most crowded trade in the world from a behavioral or investment DNA perspective, and the moment you get even a whiff of the ECB or BOJ backing down from or reaching its limit of greater foolishness, you are going to get a rush to the exit on ALL sovereign bonds that will shake global capital markets to their core. It’ll be good times till then, as it always is, and I am seeing zero signs of Central Bankers backing down from their greater foolishness. But we have once again set up the global financial system as an inverted pyramid, with a $10 trillion asset class poised on a single, solitary piece of Common Knowledge —– what everyone knows that everyone knows.
In 2008, the $10 trillion asset class of residential mortgage backed securities (RMBS) was entirely based on the Common Knowledge that it was impossible to have a nationwide decline in U.S. home prices. When that Narrative failed, the entire inverted pyramid came crashing down. In 2016, the $10 trillion asset class of negative rate sovereign bonds is entirely based on the Common Knowledge that there is no limit to the greater foolishness of Central Banks. If this Narrative fails, the entire inverted pyramid will come crashing down again. Hence my punchline: monitoring this and related status quo protecting Narratives (like
the concerted effort to paint Brexit as a one-off blunder, just like
Bear Stearns was painted in 2008) is the only thing that really matters for our investment reality. "
