Monday, December 14, 2015

High yield junk bonds are imploding: We're DOOOOMED!!!

 - by New Deal democrat

The market for junk bonds is imploding.  Prices for CCC-rated corporate bonds are down 21% from their peak: 


Oh, wait.  I'm sorry, that was 1998 Asian currency crisis.  It was another 2 years and 9 months after that implosion before a US recession occurred:

This is the current graph of CCC-rated corporate bonds:

They are down 17% from their peak, less than the 1998 carnage.

There were some important differences between 2008 and 1998.  In 2008:

  • the derivates were centered on the lifeblood of the US economy: housing
  • an oil price spike of 100% in 2 years had just occurred
  • the underlying economy was already in contraction
In contrast, in 1998:

  • the issue was centered on a particular corner of the market:  foreign currencies
  • oil was in the process of making a secular bottom
  • the underlying economy was in expansion
While a bond implosion is never to be lightly dismissed, I think it is pretty obvious that our current situation, where the carnage is centered on the Oil patch and other commodities, and the service economy remains in a decent expansion, is more like 1998.

The bottom line is that, while low grade corporate bonds almost always blow out on the cusp of of early stages of a recession, the converse is not true.   You can have a junk bond blowout without triggering or indicating a recession. 

I suspect it won't be over until a dead whale - maybe a good-sized energy producer or utility - washes up on the beach, prompting Fed and/or Treasury action, just as the bankruptcy of Long Term Capital Management did in 1998.  But so long as the consumer keeps buying more houses and cars, and generally spending as measured by real retail sales, I don't see any imminent general problem.