With modern day central banking and its interest rate suppression and “puts” under equity markets, those markets are officially the last to get the joke. Other markets began recognizing the looming debt contraction and deflation back in the end of 2014, when commodities crashed. That crash has worked its way up real economy supply chains—intermediate and final goods—transportation, manufacturing, and retailing, finally hitting holdouts like autos and restaurants. On the finance side, credit spreads have been widening relentlessly. What to make of a recent respite? From Wolf Richter at wolfstreet.com:
And since stocks follow junk bonds….
Junk bonds started to decline in June 2014, and earlier this year threatened to implode. Contagion was spreading from the collapsing energy sector to the brick-and-mortar retail sector, telecom (Sprint), the media (iHeartRadio), and other sectors. It was really ugly out there.
As junk bond prices got beaten down, yields soared. The average yield of BB-rated bonds,the top end of the junk-bond scale, according to the BofA Merrill Lynch index, went from 4.2% to 7.07% between June 2014 and February 11, 2016. For CCC-and-lower-rated junk bonds – the bottom end of the scale, deemed to be within uncomfortable proximity to default – the yield BofA Merrill Lynch index shot up from around 8% to 21.5% between June 2014 and February 12, 2016.
But then the Fed heard the screaming from Wall Street about the chaos in the markets, with junk bonds losing their grip and large swaths of stocks careening deeper into a bear market. Incapable of any independence whatsoever, it brushed rate hikes off the table and changed its verbiage. What ensued was a marvelous rally all around, particularly in bonds.
In two months, the beaten-down junk-bond ETF (HYG) soared 9.1%, though it remains 14% below its recent peaks in April 2013 and June 2014. The yield of the BofA Merrill Lynch index for BB-rated bonds dropped 171 basis points to 5.36%. And at the low end of the scale, all heck broke loose. As these beaten-down bond prices jumped, the yield of the BofA Merril Lynch index for CCC-and-lower-rated bonds dropped 369 basis points to 17.8%. A huge two-month rally (circled in red):
Default or bankruptcy, no problem. It’s been that kind of rally.
So far this year, there have been 37 corporate defaults by S&P-rated issuers in the US, the highest year-to-date since 2009 when there were 53. This wave of defaults is expected to become a tsunami, not because the Fed is going to raise rates, which it might not, but because over-indebted money-losing companies with declining revenues have been pushing their luck, and investors have finally woken up.
To continue reading: OK, I Get it, this Junk-Bond Miracle-Rally Is Doomed