Posts Tagged ‘corporate bonds’

Limited Liquidity in Corporate Bonds is Another Canary in a Coal Mine

Limited Liquidity in Corporate Bonds is Another Canary in a Coal Mine

Taxidermy canary under glass dome.

Courtesy of Rom Badilla, CFA – Bondsquawk.com

Bloomberg is reporting that liquidity is harder to come by as trading costs soar. 

The gap between the cost to buy and sell corporate credit reached the widest in nine months in another sign that investors are increasingly wary of all but the safest government securities amid Europe’s sovereign debt crisis.

The bid-ask spread for credit-default swaps on U.S. investment-grade bonds surged to an average 8.86 basis points as of May 21 from 5.42 basis points a month ago, according to CMA DataVision prices. The difference jumped to a one-year high of 10.57 on May 7, from as low as 3.1 in 2007.

Higher trading cost is not just centered on Credit Default Swaps but also their cash bond counterparts.

The bid-ask spread for AA rated U.S. corporate bonds has increased to about 5 basis points from about 1 basis point earlier this year, said Mark Jicka, managing director at Mizuho Securities USA in New York. The gap for lower rated investment- grade debt has widened to about 10 basis points from 5 basis points.

Liquidity begins to suffer as bond investors sell their holdings, flooding the market with supply.  Also, liquidity can tank as demand evaporates as dealers hunker down by either passing or giving “throw-away” bids to avoid building inventory and taking on risk on their balance sheet.  Furthermore, most dealers will widen out the bid and ask for bonds in their inventory in order to be compensated for the risk of holding it and the event of any deterioration of the credit.

I have seen similar markets where liquidity is poor and finding an exit on a corporate or mortgage bond is difficult.  The Long Term Capital Management episode in the late 90’s and the recent subprime crisis is a good example of poor liquidity during uncertain times.

When Wall Street begins to go into risk aversion mode where they are reluctant to buy bonds from an investor, its a clear signal that choppy waters are ahead.

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Corporate Bonds: From Cheap to Rich

Corporate Bonds: From Cheap to Rich

Courtesy of Jake at Econompic Data

In March I loaded up on both investment grade and high yield bonds (see Are Corporate Bonds a Screaming Buy?) as a long term investment (the key I thought was long term).

Yet by July, I was already beginning to cash out of the positions as I thought they had rebounded too far, too fast. 5% more gains for the investment grade and 20% for the high yield universes gets us to a point where bonds went from CHEAP to what now seems RICH in just about 6 months. Bloomberg details the implications and relative value of bonds to equities:

Stocks offer greater value than bonds and are poised to “catch up” with a rally in corporate debt, according to Rod Smyth, chief investment strategist at Riverfront Investment Group LLC.

The CHART OF THE DAY shows that the difference in yield between corporates and 10-year Treasury notes has narrowed more quickly than the Standard & Poor’s 500 Index has risen since March. The yield comparison is based on a Moody’s Investors Service index of Baa-rated debt. Smyth and colleagues Bill Ryder and Ken Liu had a similar chart in a report yesterday.

Since December, the yield gap has fallen to 2.9 percentage points from a peak of 6.2 points, according to data compiled by Bloomberg. This spread is near its lowest level since January 2008, when the S&P 500 was about 22 percent higher.

“‘Animal spirits’ are returning to Wall Street even if they are still suppressed on Main Street,” the report said. Spreads have narrowed so much that stocks have more room to rise than bonds, especially as earnings increase, it added.

Smyth isn’t the only strategist whose focus has shifted to shares. “Equities no longer look expensive relative to corporate bonds,” Andrew Garthwaite, a global strategist at Credit Suisse AG, wrote in a Sept. 18 report. He downgraded credit, or bonds, based on relative value.

While I am much less than bullish (actually bearish) on equities than those quoted in the article, it is suspicious how far high yield has rebounded in 2009 as compared to equities. While those BBB bonds (as detailed in the article) are now up more than 20% YTD, high yield corporate bonds are now up almost 50%.

ytd corporate bond performance

Source: Barclays

 


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Junk Bond Defaults Worst Since Great Depression. So Why Is The Market Rallying?

Junk Bond Defaults Worst Since Great Depression. So Why Is The Market Rallying?

Courtesy of Mish

Numerous people have asked for an update to Corporate Bond Spreads Key To Continued S&P Rally.

Specifically, inquiring minds are interested in my statement "It will pay to keep one eye on the credit markets to help ascertain long-term equity direction. In August of 2007 the corporate bond market cracked wide open. Although the S&P 500 made a new high in November, the corporate bond market didn’t. It was the mother of all warning calls that most missed."

Here are some charts that show what I mean.

S&P 500 vs. BAA Corporate Bonds vs. 10-Year Treasuries

click on chart for sharper image

The above charts shows that BAA corporate bond yields (one step above junk) were rising throughout 2008 and started soaring right before the stock market waterfall plunge. The 2009 rally started in March with the BAA yield dropping and the 10-year treasury yield rising.

A falling BAA-10YR spread is a measure of increased willingness for market participants to take on risk as the following chart shows.

click on chart for sharper image

The above charts courtesy of Chris Puplava. Annotations by me. Rising BAA to 10-year treasury yield spreads starting August 2007 was a big warning sign.

Not many have access to a Bloomberg terminal that produced those charts but here is something that everyone can easily watch.

HYG – High Yield Bond Fund vs. S&P 500 SPY

click on chart for sharper image

HYG – High Yield Bond Fund vs. S&P 500 SPY

Here is a closeup detail for 2009.

click on chart for sharper image

Junk Bond Default Rate Worst Since Great Depression

Last week the junk bond default rate hit 10.2 percent.
 

The U.S. junk bond default rate rose to 10.2 percent in August from 9.4 percent in July as the worst recession since the 1930s left more companies unable to pay off debt, Standard & Poor’s data showed on Thursday.

The default rate is expected to rise to 13.9 percent by July 2010 and could reach as high as 18 percent if economic conditions are worse than expected, S&P said in a statement.

Default rates have surged from less than 1 percent in 2007 as an economic downturn squeezed corporate revenues and a global credit


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Corporate Bond Spreads Key To Continued S&P Rally

Corporate Bond Spreads Key To Continued S&P Rally

Courtesy of Mish

Want to know where the S&P 500 (SPY) is headed? The corporate bond market likely holds the answer.

So far this year, investment grade debt sales are on a record pace according to the article Blackstone Group to Sell Debt as Investment-Grade Spreads Widen.

Bloommberg notes that Blackstone (BX) joined Microsoft Corp. (MSFT), the world’s largest software maker, in making a debut offer this year and that investment-grade debt sales of $774 billion are on pace to reach a record.

Meanwhile yield spreads on corporate debt vs. treasuries have declined from 603 basis points on Jan. 2, to 254 basis points today according to Merrill Lynch & Co.’s U.S. Corporate Master index.

Access To Debt Markets Keeps Zombie Corporations Alive

Ability to raise cash now will keep many zombie corporations alive. GM went under when its borrowing dried up. Ford (F) stayed in business because it had a bigger pile of cash relative to its burn rate.

Thus it’s no wonder that stocks are rallying in the face of record demand for debt, demand that has dramatically reduced long term corporate borrowing costs.

“Liquidity is the name of the game for financial-related firms,” said Guy Lebas, chief economist and fixed-income strategist with Janney Montgomery Scott LLC. “Many issuers as well as buyers realize that the improvement we’ve had in spreads over the last eight weeks marks the final step in the credit rally for 2009.”

23 Day Rally In Corporates

The question now is where to from here? The article notes the investment grade bond rally lasted 23 consecutive days, ending two days ago. The widening today is a statistically irrelevant 1 basis point.

Evidence of a pullback is more readily apparent in junk bonds.

Yields on high-yield, high-risk, bonds relative to benchmark rates widened 14 basis points yesterday to 878 basis points, the third straight day of increases after 16 consecutive days of tightening, according to Merrill Lynch & Co’s U.S. High-Yield Master II index. High-yield notes are rated below BBB- by Standard & Poor’s and less than Baa3 by Moody’s Investors Service.

S&P 500 During Corporate Bond Rally

click on chart for sharper image

Keep an Eye on Bonds!

As long as corporate bonds fetch a good bid, which in turn allows companies to raise cash at decreasing costs, the


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Phil's Favorites

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