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How To Profit From The Coming High Yield Meltdown
The credit cycle has finally turned: one can see it everywhere - from the rapidly deteriorating corporate fundamentals, to the recent surge in defaults and downgrades, to the tightening lending standards, to the most obvious - sliding asset prices. Nowhere is the bursting of the credit bubble more obvious than in the spread between junk spreads and the equity market,

Yes, equities may not have gotten the memo yet, but they will, as will all other skeptics once they read Ellington Management's analysis laying out all the telltale signs that showcase the turning of the credit cycle.
What does that mean for investors? Conveniently the very same Ellington, which recently did a remarkable job of explaining why the credit party is now over, has proceeded to layout how to profit from the upcoming credit turmoil.
Here it the answer:
Given the fundamental factors in place that should support the demand for housing, we believe the eect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect signicant spillovers from the subprime market to the rest of the economy or to the nancial system."
Ben Bernanke, May 2007
For my own part, I did not see and did not appreciate what the risks were with securitization, the credit ratings agencies, the shadow banking system, the SIVs - I didn't see any of that coming until it happened."
Janet Yellen, November 2010
Complacency today about the risks of contagion from the weakest segments of high yield to the rest of the corporate credit markets is strongly reminiscent of the complacency about contagion risks from subprime in mid-2007. At that time, investors and regulators realized that the sharp increase in subprime delinquency rates was an issue, but believed that losses would be contained to that sector. Even though housing leverage was at all-time highs and home prices had peaked a year prior, markets did not believe that other sectors were at risk. Today, with corporate leverage ratios at all-time highs and a year after corporate profits have peaked, markets are again largely ignoring the risks of contagion from the most distressed sectors of high yield to the rest of the corporate credit sector.
There is a silver lining to all this doom and gloom. Despite all of these warning signs, the window of opportunity is still wide open, with market prices and implied volatilities now back around where they were before the market swoon during August and September.

Like most turns in the credit cycle, it is uncertain exactly when the bottom will fall out of corporate credit markets, but the catalyst is likely to be an unexpected major event, perhaps even a single company getting into trouble. While we have been bearish on high yield for over a year now, we didn't think the conditions were yet ripe for a collapse. Now they're ripe.
As corporate leverage unwinds, distortions that have been magnified in credit index tranches are set to dissipate and eventually reverse. Yield-seeking investors can obtain leverage by buying equity and mezz tranches of the CDX HY and IG indices, compressing spreads at the bottom of the capital structure. We think the 0-35 tranche of CDX HY has the potential to be completely wiped out - not unlike the mezzanine mortgage bonds (subprime BBB through AA) that eventually got wiped out in the GFC. Banks, which have been slapped with onerous capital charges on low-spread synthetic instruments, no longer provide the bid for the top of the capital structure that they used to. In order to complete the capital structure, banks must now find a buyer for the senior and super-senior tranches that yield-hungry investors don't want. This double-whammy of spread compression at the bottom and spread widening at the top presents capital structure opportunities that we have profited from in recent years. As the credit cycle turns, we expect these opportunities to change and likely become more compelling.
Opportunities Using Single-Name CDS
Different markets are telling us very different things about the price of credit risk today. As shown in Figure 23, the S&P LSTA Leveraged Loan 100 Index, which is a total return index designed to track the performance of the largest institutional leveraged loans, has declined almost 5.9% since June, while the CDX HY S24 index has declined by only 0.1%. These indices, which measure similar risks, tend to move in tandem. Most of this divergence has taken place since late September. In October alone, CDX HY S24 returned 3.5%, compared to -0.6% for the S&P Leveraged Loan 100 Index. This outperformance coincided with by far the strongest month ever for high yield ETF flows.
Using single-name CDS data, we are able to separate out the components of this outperformance since June to better understand whether we think it will revert. Nearly a third of this outperformance (1.23% of the 4.05% didifference) is a move in the basis between the CDX HY index and its constituents. This move is purely technical, reflecting an unusually large premium at which CDX HY currently trades to its constituents. Moreover, this basis has historically mean-reverted, especially when the basis is greater than 1% of NAV (today it is closer to 2%). The conclusion we make from the graph below is that two factors are at work: not only has single-name CDS outperformed the leveraged loan market, but the CDX HY index has outperformed single-name CDS. The price differential creates a large wedge between CDX HY and leveraged loans, which supports our thesis that synthetic corporate credit is especially overpriced today.

Opportunities in Corporate Credit ETFs
Perhaps the scariest corner of the corporate credit market today is the market for corporate bond ETFs and open-ended mutual funds. These funds, such as the LQD, HYG, and JNK ETFs, provide daily liquidity to investors where the underlying collateral is much more illiquid corporate bonds. These funds are scary because liquidity has been tested in only one direction. Fund flows have been mostly one-sided over the past 5-6 years. Retail investors and institutions have been buying fixed income ETFs at a record pace in their search for yield and liquidity.
Who will take the other side when these massive flows reverse? The answer before the crisis would have been the banks. Now the answer is much less clear. The spate of recent failed placements in distressed loan markets is symptomatic of a liquidity vacuum. Not only have banks reduced their own market-making activities in corporate bonds due to new onerous bank capital requirements, but banks have also wound down their repo financing businesses that are the lifeblood of cheap financing for non-banks to provide liquidity in corporate bonds.
Fixed income ETFs provide daily liquidity to investors by allowing authorized market participants to create or redeem ETF shares in exchange for the underlying corporate bonds at a NAV quoted using the bid prices of the underlying collateral. These authorized participants can therefore make a profit if ETF prices deviate sufficiently far from fair value, a mechanism that keeps these ETFs trading very close to NAV.
However, if flows are large enough to overcome the balance sheet capacity of these authorized participants, ETF prices could theoretically diverge significantly from NAV, and market-makers could be forced to liquidate their positions in the cash bond market. This divergence occurred during the GFC and to a lesser extent during the Euro crisis of 2011.
It is this sudden rush to the exits that concerns us most, in part because it will be hard to see coming. If a large group of investors suddenly decides to sell, there may not be enough market-maker capacity to take the other side. When these ETFs become rich to NAV or when the cash-synthetic basis gets very tight, we can use corporate bond ETFs as a tail hedge or as a source of alpha. The cost of these tail hedges is often surprisingly low.
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Doom!
Let this shit collpase already, I'm running out of ink to type with.
I'm running out of paper to write this crap.
I opened a small MBS securities position over the summer.
I want some " payback", from these cock-sucking vampires.
I'm shorting debt, with a vengeance. It's for CONTROL!
My Mortgage Backed securities trade is doing well. I used the procedes from My WELL published corporate debt trade.
Stay Out Of The Casino, until January, "16
What do you think about the ETF: IGS
http://etfdb.com/etf/IGS/
Short Investment Grade Corporate (inverse bonds)
It's NOT completely, "inverse bond ETF's"..
You made my day... People are "waking up".
Stay out until '16 is only 4 weeks away... a prediction likely doomed to failure. Unless you have god's ear -- and by that I mean goldman's loyd.
http://www.investopedia.com/articles/bonds/09/what-happens-to-single-nam...
OK, so what happens in a credit event? You submit to an auction. If you think the process won't be rigged, you haven't been paying attention.
If you sit in on a poker game and don’t see a sucker, get up. You’re the sucker.
There's an old saying that seems to apply well to this article - the more complex the description of a financial instrument, the more likely it's a fraud.
Here's a simple explanation for other financial protection you can get in just 2 words -
Buy Gold.
I'll be playing SJB when the end is near
Sounds raesonable, when is the end near?
if the fed follows predicted rate increase, I'm guessing within a year. i hold a small amount currently. been hovering high 27s to 28
I am already playing SJB, buying whenever it dips below $28.
Luckily liquidity issues are always resolved with free money on tap.
Those who do not understand Elliott Wave analysis believe the drivvel being spouted above- it makes fundamental sense. But the unfortunate truth is that Yields are about to explode (not implode) and both bond and stock prices are on the verge of systemic collapse (that both will collapse simultaneously is counter-intuitive but it will happen). The next few months will see yields skyrocket and stock prices fall incessantly, taking with them real estate values, student loans and most important of all, bond prices - especially annuities. Annuities are currently dependent on junk bond prices. When JB yields rocket into the stratosphere insurance companies which rely on junk bonds will be decimated. Mortgage loans being hedged by 10 year treasuries will be decimated. The cascading collapse of insurance companies will affect both banking and other financial institutions in a way no one can yet see. The 2008 financial collapse will look like a walk in the park by comparison.
Real estate prices were the catalyst for the 2008 economic crisis... bond yields will be the catalyst for the 2016 economic crisis. The start of the next crisis is only weeks away. Protect yourself accordingly.
Fremannx
STFU nostradomas. You don't know jack shit.
I know it's Nostradamus.
Short the equity, pick up the yield.
Yawn. Wake me when it ever happens...
Yep, heard this for how many years now? Bond shorts are the most persistent losers in history.
Here are some signs of a coming recession.
1. Factory orders continue to drop
http://www.zerohedge.com/news/2015-10-02/us-factory-orders-flash-recession-warning-drop-yoy-10th-month-row
2. Default risk spikes
http://www.zerohedge.com/news/2015-10-02/us-financials-default-risk-spikes-2-year-high
3. M&A set record
http://michaelekelley.com/2015/05/29/mergers-and-acquisitions-set-record/
4. Fed sees 2 bubbles
http://michaelekelley.com/2015/02/20/fed-warns-of-two-bubbles/
o Commercial Property higher than pre-2007 level.
http://nreionline.com/finance-investment/cre-prices-are-now-officially-above-pre-recession-peak
o Global Corporate Debt Market hits $5 trillion.
http://fn.dealogic.com/fn/DCMRank.htm
5. Iron ore prices tumble
http://www.marketwatch.com/story/iron-ore-prices-keep-crashing-adding-to-global-growth-fears-2015-11-30
6. Baltic dry shipping index tumbles
http://www.marketwatch.com/story/shipping-index-falls-to-all-time-low-stoking-fears-about-global-growth-2015-11-19
Here is how to prepare.
http://michaelekelley.com/2014/10/16/8-things-to-do-when-recession-happens/
Here is how to get your mind off this stuff.
http://michaelekelley.com/category/humor/
Good luck!
As my name implies, I am working class (poor?) and have been sitting it out and not putting my meager savings into the stuck-market. I would like to know, would it be decent to hold on longer and wait for the drop to invest in the stock market? I have my meager savings in a bank at 1.25% interest, which is basically losing any value long term, but I know it is somewhat safer than in the market. Opinions? Thanks.
If all you have is meager savings it should be kept in a rainy day fund. Not invested (ie gambled) in anything.
Thanks. Thats what I thought. It's in a bank, earning a measly 1.25%, but thats better than losing it all.
"...It's in a bank..."
Uhhhhhhh
But he sure does talk purty!
Buying and selling HYG based on its downward trend line and just looking at stochastics has been an easy trade for months.... Just use a stop.
As for the article, its like all the others. Don't bet on it until it happens, trying to time it will wipe you out.
I'm a little slow. Are the prices of JNK and HYG going to go up or down when the brownies hit the fan??