The Corporate Bond Party Is Near Over
Massive corporate bond issuance in recent years is making bonds look more like stocks.
Investors searching for clues as to where the next market upset might come from ought to have corporate bonds on their radar.
“It can’t continue forever. The nature of exponentials is that you can push them out and eventually, disaster happens.” – Gordon Moore, Moore’s Law.*
Recent years have seen massive corporate bond issues
The magnitude of corporate bond issuance has increased corporate leverage and is causing credit quality to deteriorate. Institutional investment managers most certainly have this on their radar – both stock and bond managers. It ought to be on Individual Investors’ radar too.
“Highly rated companies sold a record $1.111 trillion of bonds in the U.S. in 2013.” – WSJ “Sales of investment-grade corporate bonds in the U.S. reached an all-time high for a second straight year.” – Bloomberg.com “Global corporate new bond issuance topped $3 trillion in 2012—the highest amount since 2009.” – S&P Credit Research
Increased leverage means more risk
This increase in corporate debt issued has dramatically increased corporate debt to equity ratios. Increased leverage elevates returns … and risks.
“Company debt loads in the U.S. are approaching the highest level since the aftermath of the financial crisis.” – Bloomberg.com “GIVEN that the recent financial crisis had its roots in the credit markets, it is natural that policy makers should regard signs of excess in the markets with extreme caution.” – Economist.com
Up the yield curve means more risk
“… investors are indulging in another desperate “hunt for yield” akin to the one that sparked the subprime-mortgage boom before the crisis.” – Economist.com “Sales of dollar-denominated corporate bonds soared to a record for the second straight year, led by speculative-grade borrowers.” – Bloomberg “high-yield offerings also reached an annual record” – Bloomberg “Global junk bond issuance hits all-time high in 2013” – CNBC “Junk Bonds at $2 Trillion.” – Bloomberg
Down the credit quality curve means more risk
Investors are getting careless
As the same time as corporate bond quality is declining, bond investors are bypassing tried and true tenants of good credit quality practices.
“When interest rates are extremely low, everyone chases yields without doing the work.” – Pionline.com “When things are rollicking and the market is permitting low-quality issuers to issue debt, that’s when you need a lot of caution,” – Bloomberg “the number of covenants per transactions in the loan market is at record low levels.” – Economist.com
Bond vigilantes are starting to voice their displeasure.
Canadian corporate bond issuers are at the party too.
And so is Europe and Emerging Markets
Is it time to leave the party?
BCA Research says there is still plenty of time. “Tighter financial conditions are a risk to the corporate sector especially if they coincide with a period of heavy refinancing requirements. The refinancing wall comes into play beginning in late 2016 through 2018.” While Deutsche Bank says … “while we’re not in a bubble now, we could be if 2014 is like 2013 on the macro front. ”
*Moore’s Law (1965) states that computer memory size and processing speed will double every 18 months and cost will halve.
_____________________________________________________________________________________Next time? More Risk Management. Doug Cronk CFA, PRM is a Pension Investment & Risk Management Officer