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The Corporate Bond Party Is Near Over


Massive corporate bond issuance in recent years is making bonds look more like stocks.

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IN SUM

Investors searching for clues as to where the next market upset might come from ought to have corporate bonds on their radar.

DETAILS

“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

“budding signs of deteriorating credit quality in the high-yield space” – BCA Research  “Portfolio managers pessimistic on credit default” – Pionline.com

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.

“Bad fiscal reputation hikes rates on Illinois bonds.” – Reuters.com  “China allows first corporate bond default” – GARP.org

Canadian corporate bond issuers are at the party too.

“Corporate Canada sets borrowing record in rush to debt market” – Globe  “debt issuance by Canadian non-financial companies has reached record levels” – FP

And so is Europe and Emerging Markets

“Corporate debt is rising to potentially dangerous levels in Europe and some emerging markets.” – WSJ  Yet, “Yield-hungry investors are snapping up anything that offers decent returns.” – Globe

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.

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Next time? More Risk Management.
Doug Cronk CFA, PRM is a Pension Investment & Risk Management Officer
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2 Comments Post a comment
  1. Gordon Ross, CFA #

    You do a good thing to cite authoritative sources whose comments will be seen later to have called the turn, after it happens. The first task of Investing is to assess risk while seeking return. Too many behave as though risk is not risk unless it happens. You have helped by reminding that return is not return unless it happens.

    Like

    April 29, 2014
    • Yup. Investors tend to focus on return and not see the building risk(s).
      “Risk is not risk unless it happens”, “return is not return unless it happens”. Nice. I may have to quote you on this.
      Thanks for your comment.

      Like

      April 29, 2014

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