Tuesday, August 20, 2013

Don't Look Now But Things Are About To Get Nasty In the High-Yield World (JNK; HYG)

The symbols are a couple of the more popular junk bond funds.
Treasuries have underperformed lower rated paper, here's the iShares 20 year bond fund vs. the Barclays High-Yield:
Chart foriShares Barclays 20+ Year Treas Bond (TLT)

Every dog will have its day and as the emancipated slave said to his former master: "Bottom rail on top now boss".
Here's SoberLook:

Weaker earnings will result in higher corporate default rates; "zombie companies" yet to be hit
...So far default rates have been extraordinary low - around the levels seen during 2005-2007 "bubble" years.

US HY issuers default rate (source: JPM)

Increasing numbers of middle market firms are having difficulties growing revenue or even losing money and yet obtaining all sorts of financing (see post). The current earnings situation is simply not consistent with the current level of default rates.
CS: - ... the current levels of companies losing money on both sides of the Atlantic is rising. This is not yet a phenomenon in the largest companies – which is why Wal-Mart might be very important – more, it is a problem in the medium-capitalisation range. But it would normally be associated with a very much higher high-yield default rate and therefore much tighter financing conditions of which all markets, not just credit markets, would have to take notice.
Source: CS

As the percentage of money-losing firms rises, corporate default rates should follow. The chart below compares the two trends: "Current profit performance is consistent with a default rate of 6%, not the current 2.8% in the US …"