"Waiting For The World To End" - Bond Rout Bodes Badly For Exuberant Equity Investors

It was a tough week for stock market investors but the primary driver of the chaotic crumble in small caps and tech stocks was not one of the usual suspects and even for those who consider themselves 'hedged' or balanced it was the worst week in 7 months.

The blame for this blight on Americans' wealth was placed squarely on the shoulders of the bond market and its violent and high velocity lurch higher in yields.

Yields rose across the curve on the back of strong US economic data and hawkish comments from Federal Reserve Chairman Powell, forcing equity investors to reevaluate the higher rate environment.

To be sure, the absence of uncertainty has been bewildering given the fact that the US government’s budget deficit has swelled, contributing to the country’s debt load, now at $21.5 trillion. Meanwhile, corporate America has gone on a borrowing spree to take advantage of near-record low rates. In fact, according to Bloomberg, excluding financials, S&P 500 companies have more than doubled their borrowings to $5 trillion over the past decade.

“There are a lot of people waiting for the world to end because of this bond market,” said Brad McMillan, chief investment officer for Commonwealth Financial Network, which oversees $156 billion.

“Low rates will keep going forever -- a lot of justification for high valuations is based on the assumption. That assumption is largely broken.”

And, as Bloomberg  notes, prophesies of doom are everywhere.

There’s billionaire investor Stan Druckenmiller, who says our “massive debt problem” will ignite a crisis.

Oaktree Capital’s Howard Marks warns that public and private debt will be “ground zero when things next go wrong.”

And Citadel’s Ken Griffin sees a credit binge ending badly.

And they are right to worry, because if interest rates rise and growth slows, companies are bound to see to their financial soundness deteriorate. More than $1 trillion of investment grade corporate bonds could be cut in the next downgrade cycle, according to analysis this week by Morgan Stanley.

"Leverage is near all-time highs, and companies used tax reform proceeds for buybacks instead of paying down debt,” said Max Gokhman, head of asset allocation for Pacific Life Fund Advisors, which manages $40 billion.

“More than triple the debt that came due in 2018 will be due each year from ’19-’21. If yields go up, there’s real concern about companies’ ability to reissue and keep their leverage.”

And that concern is starting to be priced into markets with the bond market's 'VIX' - The Merrill Lynch MOVE Index tracking Treasury volatility - rose almost 20 percent this week, the biggest jump since 2015.

We await the contagion.

And if The Fed keeps up its pace of balance sheet normalization, things are about to even uglier, even faster...

Strangely, the clever talking-heads on business TV proclaim that rates are going up for the "right" reason, so have no fear average-joe-investor... we wait with bated breath for one of them to drop the 'c' word when this really starts falling apart - "Contained."