How the Junk Bond Bubble Supports Rising Equity Prices

Yesterday, I was asked about statements I have made on numerous occasions that the recovery of the junk bond market helps explain the rise in equity markets. Here is the specific question:

Mish,

Can you explain why you frequently say that the corporate bond market supports the equities market? I don't see why it would have the major effect you seem to claim it does.

Let's go over the reasons once again.

• Companies that cannot get financing go out of business.


• In March of 2009 many corporations poised to go under because they could not get financing had exceptionally low stock market valuations. Even GE was on that list. Those stocks rose many multiples after Bernanke managed to revive the junk bond market.
  


• When companies issue long-term debt at lower and lower yields, their interest expense drops.


• The entire atmosphere of chasing yields lower is a sign of increased speculation across the board. One should expect stock prices to at least be firm in such conditions.

Everything changed when Bernanke stabilized junk bonds. Interestingly, Bloomberg discussed this situation today in Top Stories.

Maturity Wall Crumbles as $482 Billion of Debt Refinanced

The wall of bonds and loans maturing through 2014 has crumbled by $482 billion, or 44 percent, since 2009, reducing the threat of defaults and allowing companies to bring riskier deals to market. The amount of debt due in the next four years dropped to $671 billion, from $1.2 trillion in 2009, according to JPMorgan Chase & Co.

Some $163 billion of bonds and loans come due in 2011 and 2012, or about 60 percent of the refinancing activity in 2010. Clear Channel Communications Inc. said it plans to sell $750 million of bonds to repay $500 million of short-term loans.

Stronger economic growth and the Federal Reserve´s decision to keep benchmark interest rates at almost zero, while pumping $600 billion into the financial system by purchasing Treasuries, have driven down yields and spurred demand for low-rated debt. That´s allowed companies to seek new borrowings with fewer provisions that protect investors.

"The wall of worry has been greatly reduced," said Sabur Moini, the high-yield money manager at Los Angeles-based Payden & Rygel, who oversees about $2 billion of speculative-grade debt. "You've had a big rally for the last two years and that's allowed companies and underwriters to be more aggressive."

How much better can things get, especially with treasury yields soaring?

I believe junk bonds are priced for perfection and equities priced well beyond perfection.

Please see Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think for details.

As I have said many times, when this all matters is anyone's guess.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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