Trader Scott
Rising prices will always lead to rising confidence – always. And while a sentiment shift like this should be a concern, it doesn’t necessarily mean we should immediately “head for the hills”. But currently, there has been a noticeable sentiment shift in regards to the high yield market. The bullish economic prognostications since the election, in conjunction with the rising prices of junk bonds, have gotten credit managers to be much more sanguine about the prospects for high yield markets. From Reuters: The group’s (credit manager’s association) 12-month Credit Default Outlook Index improved to -31.3 in the first quarter from -37.9 in the fourth quarter, a big shift from -56.2 in the first three months of last year.” This is a purely sentiment-based index. And if you look at that junk bond ETF chart, the managers were quite bearish right into the lows in junk bonds in February 2016, so of course now since the rally they have regained some confidence. But they are certainly not overly bullish currently, especially on small energy companies: “Rising oil prices have helped stem the flow of companies that can’t repay their debt, but many fear defaults will pick up again soon. ‘People are wary’, said Som-lok Leung, Executive Director of the IACPM, who authored the report. There’s a slightly negative sentiment overall.” And it’s exactly the bullish economic tone since the election, along with the rising prices of junk bonds (and crude oil), which has made them “cautious”, i.e. less bearish, more confident. But just like it took the plunge in junk bonds to turn them outright bearish in Q1 2016 (right into the lows), it will be the falling prices of junk credit that will once again turn their “caution” into outright bearish – virtually everyone is a slave to “price action”.
Junk bonds have been in a secular downtrend since the 2007 highs, although they have been good performers since March 2009, especially when including dividends. Another example of – which trend are you going to be involved in. But all of the crap credit problems, on a net basis, have only been stuffed into a massive drawer and rammed shut – a drawer big enough to hold trillions of $s. This was “accomplished” thanks to the liquidity bazookas fired by the central bank PhDs, along with the government intervention. These problems will resurface, along with a strong US$, and this will be a deadly mix. This whole situation is one of the reasons for my bearishness on all the sectors heavily relying on junk bond financing – colleges and university town real estate, autos and related industries, physical stores and their REITS, these are for example. And this list also includes frackers. I’ve been bearish on FRAK for quite a while, and the rally to new highs didn’t change that view. I still expect a retest of the January 2016 lows, even though short term, there’s some support here. The frackers have done a pretty good job of becoming more efficient since the crude oil plunge into the February 2016 secular lows. But these efficiency gains will be tested when the big bond bear reasserts itself later this year, and the maturing bonds have to be dealt with. When I turned very bullish on bonds into the December lows (amid the hysterical crash predictions), that outlook was always in context of a rally within an impending huge bear market. So the frackers are going to need a very strong crude oil market to neutralize some negative junk bond market effects. The crap credit market is going to be a real game changer in many, many ways, but right now there is an eerie complacency about all of this.
Rising oil prices have helped stem the flow of companies that can’t repay their debt, but many fear defaults will pick up again soon.
Global credit portfolio managers say defaults are poised to climb in the next 12 months, and investors will demand more yield to lend money, according to a survey by the International Association of Credit Portfolio Managers, a group of mostly bankers. More believe defaults will rise than fall.
“People are wary,” said Som-lok Leung, Executive Director of the IACPM, who authored the report. “There’s a slightly negative sentiment overall.”
Even as oil prices have nearly doubled from their decade-plus low early last year, there are reasons for concern. Some say that rising rates or a slowing economy could take a toll on debt issuers, who have benefited from years of rock-bottom borrowing costs and monetary stimulus that’s slowly being reversed.
Many riskier companies have binged on debt to take advantage of low rates. That has continued into 2017, where junk-rated borrowers sold double the amount of debt in the first quarter as they did a year earlier, according to data provider Dealogic.
While the survey doesn’t portend an imminent wave of corporate repayment troubles, a rise in defaults would be a contrast to the past year. Defaults have trended down as rising oil prices have calmed the wave of distress in oil and gas, and metals and mining. Fitch Ratings Inc. expects trailing 12-month default rates in the junk-bond sector will drop to 3.2% at the end of April, from 3.9% at the end of March. That would be the fourth consecutive month in which the rate has declined.
But the economy has shown some signs of weakness lately. A key reading on economic activity, due out next week, is expected to show the economy grew at a 0.5% annual rate in the first three months of the year, according to a Federal Reserve Bank of Atlanta real-time tracker. Other data on inflation, auto sales, and retail sales have all been showing weakness as well.
The retail sector is one area of concern in the credit markets, as the struggles for firms with brick-and-mortar stores accelerate, according to Fitch. The analysts expect the default rate in the sector to hit 9% by the end of 2017.
While that may not necessarily spread to the broader market, the potent combination of high debt levels and a sluggish economy has many saying caution is justified.
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