The High-Yield Message The Bulls Ignored In 2007

Tyler Durden's picture

While high-yield bond yields are at record lows, the spread (or compensation for risk) remains above all-time record lows leaving some to suggest there is room for more compression and for the circus to continue. The credit market's disconnect from anything macro-, micro-, or cashflow-related (with CCCs now trading sub-7%) is purely a function of flow and yield-grabbing with WACC curves back at 2006 levels...

suggesting little pain for firms willing to relever to recap their shareholders. And so they pay it out... (payouts near record highs)


But there's no free lunch as credit cycles and the leverage starts to catch up... The gap between the cost of debt and equity is so high that firms have been using balance sheet resources to buy back equity and pay dividends - this has tended not to end well as there is a limit...


In late 2006, the high yield credit market surged ahead of stocks in an exuberant fanfare (heralded by many as the new normal then); it retraced quickly, only to re-accelerate (driven by the vinegar strokes of a CDO rampage) until April 2007 when it once again roared tighter (way ahead of stocks) in a final capitulative fervor.

Fast forward 6 years and in September last year (QE3) HY raced ahead of stocks (only to retrace) and in the last few weeks credit has massively outperformed stocks (selling credit protection has outperformed owning stocks by 4.4% since March 27th) in what feels very capitulative once again.

With the memory of what happened in 2007 entirely priced out of the market as financials and non-financials converge...


Is this melt-up the message most ignored in 2007?

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Yen Cross's picture

     June Gloom/

WayBehind's picture

What a joke this market is ...

YC2's picture

Do the vinegar stroke! (You close one eye) Do the vinegar stroke!

spine001's picture

The WACC model is predicting deflation and so do the negative real interest rates...

WACC is weighted average cost of capital and is equal to: Total Debt/Total Capital * Rd (1-tax rate) + Equity/Total Capital * Re

where Rd is the interest rate of the debt and Re is the expected return on equity that comes from the CAPM model ==> Re = Rf + Beta * (Rm-Rf) Where Rf is the risk free return and Rm is the market return. Rm-Rf is the market premium for taking the market risk.

Until next time,


buzzsaw99's picture

the bernank is happy that gross leverage is rising. it won't be like last time though because nobody defaults and even if they do the bernank will buy that junk again.

Sudden Debt's picture

and as a hawk he's using his eyesight to detect and protect us from any bubbles so there just isn't anything that can crash!

buzzsaw99's picture

where's that picture of ben bernanke's monitor? omg this is too funny: CNBC has learned from a former Bloomberg employee that he accessed usage information of the company's data terminals of Federal Reserve Chairman Ben Bernanke and former U.S. Treasury Secretary Tim Geithner...




found an oldie but goodie banzai while looking around:

Fuku Ben's picture

Must of missed that one +1

johngaltfla's picture

2nd most ignored message. The upcoming real estate repeat is something the media continues to gloss over like a Benghazi bayonet sodomy party. With over 350,000 foreclosures about to hit the fast track in Florida alone and many other states forcing the TBTF banksters to clean up their messes now that all the big election cycles are over, there is a tidal wave about to hit the markets right when flipping and the NAR cheerleaders thought it was all over.


In the mean time, drag out the daily charts from Jun 07 to Sept 08. It is quite entertaining watching the Fed flail and fumble and the carnage it created...

Sudden Debt's picture

after all this good news, I'M READY FOR THE BAD NEWS NOW!

Yen Cross's picture

  Long Valhalla, and skittle shitting unicorns...

kito's picture

Ben is the doctor that continues to prescribe one drug after another.....each with side effects....each needing another drug to offset the side effects from the previous drug.....nobody knows the true long term harmful effects of these drugs....they've never been used for this long.....yet everybody accepts them because to get "healthy" without the drugs would mean diet, exercise, will power....... constraint......essentially it requires sacrifice.....and THAT is NOT the American way anymore..........

Fuku Ben's picture

Tis now the very witching time of night,

When churchyards yawn and hell itself breathes out

Contagion to this world. Now could I drink hot blood

And do such bitter business as the bitter day

Abi Normal's picture

History rhymes does it not?  I am no high finance wizard, or economist, but I see nothing but pain in our future.  How does this house of cards stay up?  QE is one thing, but with all the manipulation of unemployment #'s, CDS's, of gold/silver, do we really know what is going on here?  I mean the charts are worthless right, who has any price to risk discovery any more?  I've never seen seat of the pants management of our economy like this ever?

Hey, try this, maybe that will work, oh, ok, well then try this other thing...all the while the monkeys in DC have no idea what is going on, and focus on immigration instead of fixing the spending problems we have, and getting the govt out of the way...nah they just write 'books' as new legislation, and nobody understands them, talk about complete morons!

I just wonder how much longer until this whole thing blows up???

polo007's picture

According to Bank of America Merrill Lynch:

Easy Fed policy: too much of a good thing?

The costs of easy Fed policy

Fed policy is aimed at stimulating economic activity, which involves incentivizing households, businesses and investors to take more risk. Investors have obliged, resulting in low rates, tight credit and mortgage spreads, and new all-time highs for major stock indices. But some worry the Fed is causing a dangerous search for yield that could lead to new asset bubbles and financial instability. Our assessment is that Fed policy has not led to an increase in systemic risk.

Risk-taking is good; systemic risk is bad

This piece provides a guide for monitoring financial stability and the linkages between asset markets, financial institutions and the real economy. We believe the ultimate question is whether the Fed’s policies have increased systemic risk.

This depends on the following, which we address in the note:

- Do market valuations appear overstretched and are there signs of asset
bubbles forming?

- Is there an increase in leverage in the market or an overreliance on short term funding? Would systemically important institutions be at risk of failure?

- How are the beneficiaries of easy credit using the proceeds? Are they using debt to fund risky investments, buy homes they can't afford or go on a consumption spree? Or is issuance going toward improving their balance sheets and lowering their vulnerably to the eventual rise in interest rates?

Risk transfer underway, but systemic concerns muted

We argue that Fed policies have encouraged a transfer of risk from borrowers (indebted households and corporations) to creditors (investors) who are willing to accept lower risk premiums. Increased real money participation in credit markets mitigates the systemic implications of this risk transfer. Corporate and household balance sheets are healthier, thanks in part to easy Fed policy, but signs of increased appetite for leverage in the corporate sector bear close monitoring.

Fed to stay the course

Our survey of financial conditions and systemic risk supports our base case that the Fed will maintain its asset purchase program at the current pace of $85bn/month through March 2014, followed by a 6-8 month tapering period.

QE will limit the upside in yields

The potential for a sizable rise in yields will be limited if the Fed maintains QE well into next year as we expect. We forecast a gradual rise in 10y rates by year-end.

The Swedish Chef's picture

The market is due pretty badly for a correction. But then there is QE. Flat summer and a fiery fall. Articles by Hilsenrath doesn´t matter, they will print MOAR!

W T F II's picture

Big difference between 2007 and now were top-line revenues and the related relative health of the average consumer.

This high-yield signal should be taken MUCH more seriously in our current cycle...!!

yrad's picture

Bullish Spam

polo007's picture

According to Deutsche Bank:

The lack of confidence in final demand that seems to justify corporate reticence has a mirror image in the financial sector’s liquidity trap – the fact that corporates prefer to save and not to leverage and invest. And it seems reasonable to justify the lack of confidence in the context of ongoing and unresolved fiscal tightening; household savings rates that are “naturally” capped not to go to zero or below this time; and a global sector that seems decidedly weaker. In other words, of all the Keynesian circular flow of income external drivers there are none doing any driving except corporate investment. But the Catch 22 is that corporate investment itself is restrained by the fear for the lack of the other drivers! The answer might be waiting for a pick up in the external sector; it might be seeing through the fiscal austerity and or at least suspending or reversing some of it; or it might be further improvement in the household balance sheets via housing. However all of these likely need time.

In this context we can then handicap central bank reaction functions. While we wait for something to give positively in favor of a stronger recovery, policy stays unusually easy. This then creates the dichotomy of buying more time in the near term through easier policy to deliver a proper recovery whilst potentially running the risk longer term of too much inflation the other side. The pent up monetary stimulus that exaggerates a liquidity trap now becomes a challenge to control on the other side. This schizophrenia has been played out numerous times since 2008. And it defines the unusual dislocation between ultra low real yields and high inflation expectations (inflation risk premia) that is also known as financial repression. Financial repression being one of the metrics that is supposed to encourage more risky lending and to break the liquidity trap.

The consensus of course is that after a certain amount of financial repression, the world will sufficiently improve and central banks have the tools to contain inflation so that the bulk of financial repression is contained to ultra low real yields rather than ultra high (realized) inflation. In this spirit Bernanke and now Kuroda are extremely confident. However we would actually go one stage forward. In the current low growth equilibrium there is a good chance that there is jolt to higher growth because the fiscal dynamics can never be resolved. This is particularly true for peripheral Europe and Japan; less true for the US but then partly depends on the willingness to address structural contingent liabilities. Absent that, the US might well be in the same boat as the others. In this case, the only solution is for the central banks to end up holding the majority of government claims and to consolidate their balance sheets with the government. In one fell swoop, cumulated deficits that may stretch back several years are ex post deficit financed. This would almost certainly break the liquidity trap in that it would represent a massive relief to expected fiscal tightening for the private sector. The central banks would quickly need to use their “tools” to contain a splurge in lending and control inflation. Ex post however there is no reason why inflation would materially rise, as long as liquidity was tightened commensurately with the debt relief implied by consolidated balance sheets of the central banks and the government. Moreover if G3+ acted synchronously, at least for the currency majors there may be little fall out.

So the interesting question is why not? Is there any cost of consolidation when we are otherwise in an eternal liquidity trap? The answer is, unfortunately yes. This would have to be a one shot game. Going forward governments’ would unlikely be able to borrow from the private sector for a long long time precisely because it threatened financial repression, even if only in the kind of negative real rates ex ante rather than even more negative ex post. Instead, government would be obliged to run balanced budgets. These authors don’t think this is necessarily a bad outcome. However it does mean that if and when consolidation comes, as much as possible needs to be consolidated otherwise fiscal policy would be on a perpetual tightening path to run the extant liabilities down. If you are going to consolidate, do it big because you are likely to have only one chance. It may seem extraordinary to think about consolidated balance sheets but there are plenty of examples in history, particularly during wars, of deficit financing. And however outlandish and non consensus it is, remember that a few years ago we talked about QE never ending, which at the time was also outlandish. Consolidation sounds an anathema to consensus but it is a logical conclusion to the liquidity trap and the probability rises each day that growth disappoints.

DR's picture


Do you have a link to this?


I'm sure Deutsche Bank would love to have the CBs buy (monetize) the sovereign junk bonds that are stuffing all the Europe TBTF banks balance sheets....