The chart above compares the yield on 5-yr A1-rated Industrial bonds with the yield on 5-yr Treasuries. The spread, or the difference between the two, is now 35 bps, which is very close to its lowest level (31 bps) in Bloomberg's recorded history, which was reached in March, 1997—four years before the next recession would strike. Like then, investors are willing to accept a very small premium in extra yield relative to a Treasury, in exchange for assuming the credit risk of the average A-rated Industrial issuer. This also implies a high level of confidence in the ability of those companies to make good on their obligations.
Confidence in bond-land is pretty high, but that doesn't mean a recession is just around the corner. It means that the economic and financial fundamentals for corporate cash flow are very positive and default risk is very low. That will change when another recession sets in, but something—other than tight credit spreads—will have to trigger it.
The chart above compares the spread to Treasuries of 5-yr A1 Industrial bonds and the spread
to Treasuries of 5-yr swap contracts, which can be thought of as representing the credit risk of AA-rated banks. Here you can appreciate how significant the recent decline in spreads has been.
Both swap spreads and credit spreads tend to rise in advance of recessions and decline in advance of recoveries. For now, they are very low and could decline a bit more. But when spreads are this tight, it doesn't pay to put a lot of your eggs in the corporate bond basket, especially of the investment grade variety. If the economy picks up, yields are very likely to rise and default risk is likely to decline further, but it can't go a whole lot lower than it already has. The current level of credit spreads and yields doesn't offer much (if any) cushion against the negative impact of rising yields. In other words, rising interest rate risk is now of much more concern to high-grade corporate bond investors than is default risk.
Globally we see interest rates trending towards zero, so you are getting spread compression...people forget, in free markets there is no assurance of returns on savings...capital in plentiful...look for even lower rates and zero bound in the future....
ReplyDeleteYou relate that credit spreads are very tight.
ReplyDeleteI comment that this reflects Credit Madness and is seen in Pursuit Of Yield Bearing Equity Investments, such as Water Resources, PHO, Dividends Excluding Financials, DTN, and Mid Cap Value Stocks, FVL, and Global Telecom, IST, such as ORAN, PHI, VZ, T, and Nation Investment, EFA, particularly in Greece, GREK, Ireland, EIRL, and its companies, a IR, COV, MNK, CRH, and RYAAY, topping out and turning over. The extinction of the fixed income investor, whose love for Utility Stocks, PUI, XLU, has commenced on the failure of credit.
The failure of credit is underway as investors no longer trust the monetary policies of the world central banks to stimulate investment gain. The failure of credit came the week ending April 25, 2014, and constitutes the most significant economic event since President Nixon took the US off the gold standard in 1971, and is seen in China, YAO, ECNS, CHIX, TAO, Russia, RSX, ERUS, and the US, IWC, IWM, KRE, trading lower in value.
The trade lower in Education Services, High Beta ETFS, such as Internet Retail, FDN, Call Write Bonds, CWB, International Treasury Bonds, BWX, bearing 1.52% interest. the Floating Rate Note, FLOT, bearing a 0.43% interest, give additional evidence that the failure of credit has commenced.
The failure of credit comes with debt deflation, that is currency deflation. Said another way, investors no longer trust in the monetary policies of the world central banks to stimulate investment gain, and as a result currencies, the wheels on which investments drive, and the life blood on which nation states exist, are dying; these include Major World Currencies, DBV, such as the Australian Dollar, FXA, as well as Emerging Market Currencies, CEW, such as the Chinese Yuan, CYB.
All fiat currencies will be debased and devalued by the ongoing failure of credit; some economies will experience faster debt deflation than others.
The Small Cap Developed Market Nations, SCZ, that are at the greatest risk of debt deflation are MES, ENZL, EDEN, DFE, EWS, EWI, ENZL, and GERJ, as is seen in their ongoing Yahoo Finance Chart.
The Debt Loaded Emerging Market Nations, EMHD, that are at the greatest risk of debt deflation are IDX, THD, EPHE, THD, SCIN, EGPT, GXG, ARGT, GAF, and EMHD, as is seen in their ongoing Yahoo Finance Chart. Benson te writes Phisix Mania Rages As Money Supply Sizzles for the 9th Month!
Commodities, DBC, traded parabolically lower, as Agricultural Commodities, RJA, Natural Gas, UNG, UNL, Oil, USO, Base Metals, DBB, and Silver, SLV, traded strongly lower on the failure of currencies, specifically Commodity Currencies, CCX.
The trade lower in Commodities, DBC, evidences the pivoting of the world from prosperity into austerity and opens the door to the opportunity of short selling.
Trust in the monetary authority of Banker Regime and its schemes of Global ZIRP, which began when the US Fed traded out “money good” US Treasuries for Distressed Investments of all types, such as those traded in Fidelity Investments FAGIX Mutual Fund, provided the basis for global growth and more importantly investment in an age of credit that was underwritten by the Milton Friedman Free To Choose Architecture.
The failure of credit is getting strongly underway with Commodities, DBC, trading lower; thus the short selling opportunity of a lifetime has commenced.
The failure of credit is seen in Global Financials, IXG, in particular the National Bank of Greece, NBG, is leading World Stocks, VT, lower from their April 2014, highs. The rally in High Yielding Debt Investments, JNK, VCLT, EU, EMB, HYD, EMLC, QLTB, EMCD, BABS, HYXU, presented in their ongoing Yahoo Finance Chart, is history. Australia Dividends, AUSE, which pays 4.3%, traded lower.
Is another recession imminent...?
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ReplyDeleteJames W. Paulsen, Ph.D.: "Are Bonds Cruising for a Bruising?"
ReplyDeleteEconomic and Market Perspective
"The bond market has been bolstered by many favorable
influences so far in this recovery including an uncommonly
weak recovery, a large output gap, a populace worried mostly
about depressionary /deflationary outcomes, and uncharacteristically
weak credit usage. Combined, these forces have allowed the 10-year Treasury yield to remain extremely low despite almost five years of continuous economic growth. It
has also probably lulled most investors into a mindset which
is underestimating the potential for yields to rise.
"Although real GDP growth currently remains modest and while there is very little evidence of imminent inflationary pressures, we think many factors are aligning which could cause a significant rise in bond yields before the year is over."
Paulsen then itemizes 9 reasons to support this conclusion which you made read in detail at this link:
http://www.wellscap.com/docs/emp/20140429.pdf
James W. Paulsen, Ph.D.: "Are Bonds Cruising for a Bruising?
ReplyDeleteapparently this is one of the 100% who were recently polled expected the 10 yr to trade higher in yield 6 mos hence. whenever there are so many (but 100%?) in one camp, the opposite is bound to happen