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They Call Them Junk Bonds For A Reason...

Tyler Durden's picture




 

Submitted by Tim Price via Sovereign Man blog,

They call them ‘junk bonds’ for a reason. They now constitute an offence against linguistic decency: ‘high yield’ no longer even is. Consider the chart below:

TPC1 They call them ‘junk bonds’ for a reason…

(The index in question is a benchmark for the broad high yield bond market.)

Not for nothing did the Financial Times report at the weekend that “Retail investors are getting increasingly nervous about high-yield bonds”.

TPC2 They call them ‘junk bonds’ for a reason…

In the entire history of the UK Gilt market, yields have never been as low. This suggests that Gilt buyers at current levels are unlikely to enjoy an entirely blissful investment experience.

Just to round up this analysis of bond investor hyper-exuberance, consider this last chart, which puts interest rates (in this case, the UK base rate) in their historical context:

TPC3 They call them ‘junk bonds’ for a reason…

(*The Bank Rate has comprised variously the Bank Rate, Minimum Lending Rate, Minimum Band 1 Dealing Rate, Repo Rate and Official Bank Rate.)

There is one (inverse) correlation in investment markets that is pretty much iron-clad. If interest rates go up, bond prices go down.

This is entirely logical, since the coupon payments on bonds are typically fixed. If interest rates rise, that stream of fixed coupon payments loses its relative attractiveness.

The bond price must therefore fall to compensate fixed coupon investors. So now ask yourself a question: in what direction are interest rates likely to go next ?

The bond environment, ranging from high yield nonsense to government nonsense, is now fraught, littered with uncertainty and unexploded ammunition, and waiting nervously for the inevitable rate hike to come (or bracing for a perhaps messy inflationary outbreak if it doesn’t).

There are clearly superior choices on a risk-reward basis; we think Ben Graham-style value stocks are the logical and compelling alternative.

“By sacrificing quality an investor can obtain a higher income return from his bonds. Long experience has demonstrated that the ordinary investor is wiser to keep away from such high- yield bonds. While, taken as a whole, they may work out somewhat better in terms of overall return than the first-quality issues, they expose the owner to too many individual risks of untoward developments, ranging from disquieting price declines to actual default.”

- Ben Graham, ‘The Intelligent Investor’.

*  *  *

Bonus Chart... The issuance of cov-lite (totally unprotected) bonds has not only topped the previous bubble peak but is extending... is it any wonder Yellen is concerned?

 

 

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Mon, 07/21/2014 - 09:35 | 4983064 Stoploss
Stoploss's picture

Who wants to be the first one to say rates have to go up??

Mon, 07/21/2014 - 12:05 | 4983876 flacon
flacon's picture

That depends. The oceans may turn to lemonade soon. 

Mon, 07/21/2014 - 12:11 | 4983920 The Merovingian
The Merovingian's picture

Agreed, but knowing when is where the real money is.

Mon, 07/21/2014 - 09:36 | 4983069 fonzannoon
fonzannoon's picture

The junk bond market will start to crack. It's inevitable. It will be good for UST's, Investment grade corporate's and SPY.

Mon, 07/21/2014 - 09:44 | 4983095 Hippocratic Oaf
Hippocratic Oaf's picture

Old investors chasing yield.

They don't believe they have much of a choice and spreads are so tight that traders are starting to believe the hype.

I'm buying a lot of 2-5yr AMBAC insured PR bonds at 6+% yield. Putting a lot of chips on the insurance, Radian and Assured GTY too.

My hi-grade book is non existent

Mon, 07/21/2014 - 09:52 | 4983129 fonzannoon
fonzannoon's picture

Good luck man.

Mon, 07/21/2014 - 10:01 | 4983170 bobby02
bobby02's picture

Good thing AMBAC insured all that MBS a few years back. Otherwise investors might have lost money. Hell, there might have even been a financial crisis or some such thing.

Mon, 07/21/2014 - 10:10 | 4983213 Hippocratic Oaf
Hippocratic Oaf's picture

AMBAC is actually doing well. They've been getting a lot of settlements with the banks due to all the MBS shit that you mention.

PR and Detroit have taken a bite, but they have a lot of collateral and just over 2B exposure to PR. They're also able to just concentrate on past underwritings without insuring new debt.

Of course the shit could hit the fan with more defaults (Chicago maybe)..........YTBD

Half the muni insurers should be ignored........they're worthless

Mon, 07/21/2014 - 10:32 | 4983324 bobby02
bobby02's picture

I hear you bro. But if you realy belive that AMBAC insurance is money good, fuck the Ricans - just short AMBAC CDS - you get the same exposure at a fractional of the cost. (If you're a big boy you would even have positive carry.) Hell, even short cash equity or calls is a cheaper way to express the same view.

Mon, 07/21/2014 - 10:38 | 4983358 caShOnlY
caShOnlY's picture

you only buy junk bonds with junk money, nothing else. 

Mon, 07/21/2014 - 09:38 | 4983081 Dubaibanker
Dubaibanker's picture

You mean...like this one .....from Portugal...a Western European EU country?

6,875% ESPIRITO SANTO FIN GRP (2019)

 

Mon, 07/21/2014 - 09:42 | 4983084 Mitch Comestein
Mitch Comestein's picture

I think it is amazing how high interest rates went up in the 60s, 70s over the previous 200 years.  It is interesting to see that England fought Napolian and the colonists in 1770s, 1780s, & 1812 and the yields only went to 5.5%-6%.

It makes sense to me now that bond yields have fallen so much.  After the hugh hike in yields north of 15% over 30 years there needs to be an equal reaction south over a similar time period.

It is funny that the 'yields must rise' crowd never show you the 250 year chart.  

Bonus note: Look at how long rates fell.  They fell from 1800 to 1900, bounced and double bottomed in the early 1930s.  I would say that is hard to time.  It may be best to go with the trend.

Mon, 07/21/2014 - 09:40 | 4983086 Spungo
Spungo's picture

In a centrally planned world, they can be kept low, but the consequence would be inflation because new money needs to be printed to suppress interest rates.

Mon, 07/21/2014 - 10:11 | 4983211 disabledvet
disabledvet's picture

Thus meaning you get no inflation because all the newly printed dollars ends up going into debt creation.

This is a textbook case of the Japanese "liquidity trap" that was created in response to the Twin Towers bubble of real estate and the Nikkei in the 1980's....neither of which have ever recovered.

Europe is now going through the same thing...I don't see the euro making it.

Mon, 07/21/2014 - 10:10 | 4983208 Rainman
Rainman's picture

I guess those starving for yield have an equally insatiable appetite for destruction. Same as it ever was.

Mon, 07/21/2014 - 10:29 | 4983312 SheepDog-One
SheepDog-One's picture

So they're pretty good, unless the good chance of getting kornholed happens. Ok, got it.

Mon, 07/21/2014 - 10:50 | 4983424 WTFUD
WTFUD's picture

Trying to make sense of a ponzi financial system makes no sense.

Mon, 07/21/2014 - 11:00 | 4983488 jarana
jarana's picture

% interest rates.

% bond yield.

Use arrows to feel like you are the boss...

Hope you enjoy it.

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