Junk Bond Indigestion; Musical Chairs; Take Chips Off the Table?

The first half of 2014 sported record junk bond purchases by investors thirsty for yield, no matter how absurd the bond covenants or how risky the investment.

Things may have changed in July as the following chart shows, using JNK (the Barclays High Yield ETF) as a proxy for junk bonds.

JNK Daily



click on either chart for sharper image

On a weekly chart, however, the dip doesn't even register.

JNK Weekly



So while this could be the start of a decline, it might also be nothing.

With that backdrop, please consider Bloomberg's report Junk-Bond Indigestion Burns Buyers Gorged on Record Sales.

Junk-bond buyers are showing signs of indigestion after snapping up a record $361 billion of the debt at the lowest yields on record.

Speculative-grade bonds from the U.S. to Europe and Asia are set to post losses this month for the first time since last August after high-yield debt funds suffered the biggest weekly withdrawal of 2014. Winoa SA, the French producer of abrasives for metalworking, scrapped a bond offering in Europe yesterday amid the turmoil.

“People who were complacent before are going to have their finger on the sell button pretty quickly if some of these situations escalate,” Marc Gross, a money manager at RS Investments in New York, which oversees $5.8 billion in fixed-income assets, said in a telephone interview.

There is “a whiff of ‘flight-to-quality’ in the market, though we are far short of panic,” analysts led by Michael Contopoulos at Bank of America wrote in a report yesterday. The $2.7 billion of withdrawals from junk debt was led by U.S. funds that reported outflows of $1.8 billion, with exchange-traded funds accounting for more than 60 percent of that, according to the report.

“There has been a noticeable shift in sentiment as investors evaluate whether flows are a short-term blip or the beginning of a broader trend,” Michael Sohr, a New York-based money manager at AllianceBernstein, said in a telephone interview. “We’ve got increased geopolitical risks. Perhaps some investors believe it is a good time to take some chips off the table.” 

Take Chips Off the Table?

The preceding three paragraphs from Bloomberg are rather amusing. Specifically I am referring to these phrases:

• Flight-to-Quality
• Finger on the sell button
• Good time to take some chips off the table

While it's certainly possible for an individual investor to have a "finger on the sell button" or to "take chips off the table" it is impossible for investors in aggregate to take any chips off the table.

Someone must own every bond ever sold, 100% of the time, until the bonds mature or they are called. Mathematically, 100% of the chips must be on the table 100% of the time.

Secondly, there is no such thing as a "flight-to-quality".

Rather, what happens is a major repricing event: Investors demand more yield from junk bonds as perceived risk increases. Investors demand less interest from treasuries in times of turmoil.

In a repricing event of that nature, one asset price rises, the other sinks. It's important to understand this can happen even if no shares trade!

Here's an easy-to-understand example of a no-trade repricing: Suppose the city approves a landfill at the end of your block. Without any homes being sold, the value of every home on the block would immediately decline.

Sentiment can and does change overnight (and pricing along with it) whether shares of stocks, bonds, homes, or other assets trade or not.

Every Friday the market closes for the weekend. Prices can be very different at the open on Monday, and dramatically different in a week's time. Individual issues can change even faster than indices.

Musical Chairs ThreePeat

Just like Chuck Prince, former Citigroup CEO in 2007, everyone believes they can dance while the music plays, and safely head for the door when the music stops. For an amusing recount, please see Music Stops for Chuck Prince.

Investors are fooling themselves, for the third time. It's impossible now, just as it was in 2007 and 2000, for investors to exit at the right time.

All that remains is the answer to the question: "How much more insane does it get before the junk bond bubble bursts?"  When it does burst, it's near-certain equities will go along for the ride.

And It's Gone

A reader reminded me of this South Park clip that explains everything you need to know about risky investments.



Link if video does not play: And It's Gone

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