Charlie Bilello @charliebilello posted the following chart which I replicated above, via Fred.
Let’s step back and look at the long-term picture.
High Yield Spread 2004-Present
Things are about to get worse, much worse.
The Wall Street Journal notes There Have Never Been So Many Bonds That Are Almost Junk
Percentage of Corporate Bonds One Step Above Junk
Over 40% of the entire corporate bond market, 3.15 Trillion in BBB-rated bonds is one step above junk!
The percentage of investment grade bonds rated higher than BBB has fallen from 59% in 1996 to 42.8% in August of 2018.
Bond Market Breakdown (August 2018)
- AAA $0.11 Trillion
- AA $0.59 Trillion
- A $2.60 Trillion
- BBB $3.15 Trillion
- BB $0.57 Trillion
- B $0.52 Trillion
- C $0.16 Trillion
Rise of the Zombie
In the US, 15% of the companies in the S&P 1500 are Zombie corporations. The Zombie attribute applies to firms that are unable to cover debt servicing costs from current profits over an extended period.
Prolonged cheap debt explains the Rise of the Zombie Corporations.
Zombie corporations only survive because they can roll over debt.
Fools’ Mission
The Fed is desperate to keep Zombies alive, but that keeps productivity low and it is at the expense of corporations that make better use of capital.
This bubble, widely referred to as the “everything bubble” is really an artifact of a junk bond market fueled by increasingly ignorant Fed policy since 2009.
Suddenly, No Appetite
The above chart from Stock Markets Are Wild, but Bond Markets Can Be Dangerous.
Can corporate American handle a downturn?
Netflix has gone from having very little debt in 2010 to having more than $10 billion now. Verizon now has $113 billion of debt, more than double the amount it had six years ago. By one measure, the ratio of corporate debt to G.D.P., the total level of borrowing is at all-time highs.
And with the American economy already expected to slow in 2019, the climbing costs of corporate borrowing could determine whether any slowdown turns into something much worse.
GE
On November 12, Reuters reported General Electric seeks urgent asset sales as bond fears rise.
GE had $114 billion in debt at the end of the third quarter, 3.7 times its equity and more than four times the industry average debt-to-equity ratio of 0.77, Refinitiv data shows.
Spillover
There are many investment grade bond funds that will either have to break their agreements or dump up to $3.15 trillion of debt if there are significant debt downgrades, and there will be.
This will spill over into equities in a major way.
Don’t be fooled by these stock market rallies. Bonds are due for a huge repricing event and stocks will follow in a major way.
Mike “Mish” Shedlock
It is all about capital flows around the world… not just looking at our own country perspective. There is a debt crisis around the world both public and private, that means capital will be flowing to equities… The other market to watch will be agricultural commodities once we realize we are back into mini ice age. – M.Armstrong.
Question, if the debt debacle is happening do you want to be short High Yield/Junk under the theory that they only get worse over time, or do you want to short an Investment Grade ETF under the theory that if the BBB bonds are downgraded the funds and pensions will have to sell those bonds in a hurry and you’ll see them getting hit the worst as the downgrades occur.
In theory, you want to short Junk Bond ETFs because they will earn the greatest return in the smallest amount of time. The other dynamic is those selling junk bonds will buy investment grade bonds for their safety, so investment grade bonds will fall less relative to junk binds. Bond rating downgrades lag the market so much that ratings become meaningless.
In practice, the rules can change in the middle of your winning streak. This is a known unknown since it first appeared in the 2008 bear market as the double inverse bank ETF I bought was suddenly thrust in reverse by a temporary “No shorting the bank stock” rule to support banks. The investment problem to solve now becomes: How to pick an inverse fund or short AND avoid getting blind-sided by a rule change. I would try finding a small cap loaded to gills with debt, that is NOT “too big to fail”.
Are you suggesting Mish that there is no connection at all between these so-called “markets” and economic reality?
I’m shocked. Shocked, I tells ya!
Who publishes a list of Zombies??
Just another progressively indoctrinated clown lacking aptitude to comprehend continuous functions. Who hence, conveniently, believes arbitrary classifications capture anything of real world significance, if only pontificated loudly and confidently enough, to a similarly indoctrinated gallery of dupes.
IOW, somewone from the same sewer as the ones compiling unemployment stats and most of/all the rest of the drivel being passed of as insight among the idiotoscenti.
There should be significant downgrades coming, but will the government intervene to “save the system” as it did in the last crisis? That will only delay the inevitable, but as Japan demonstrates the inevitable can be delayed for a very long time.
“but will the government intervene to “save the system”” Only if they are open for business!
I dont think Jerome Powell likes interventions. He has worked at literally every sector of the banking system and knows the ins and outs of these banks. We dont want to become Japan. Japan is no longer delaying the inevitable and is now embracing deflation. The bottom line is the air will have to come out of all assets as the Great Reset begins.
Will Powell be around long enough to do that? I think the political elite will do anything to maintain the status quo, and their power, as long as they can. That’s why AWC’s comment makes sense to me, but I hope you’re right.
CJ, I think it’s happening now
Very interesting! Thank you Mish. (But what about the timing?)