The good news? I think I’ve finally kicked this thing. The bad news? Despite today’s bounce, the market remains sick, sick, sick!
You’ve read about many of the symptoms here in Money and Markets — narrowness in market leadership, multiple sectors and indices underperforming the averages, emerging-market currency, bond and stock meltdowns, lackluster growth in many advanced economies, credit market turmoil.
But on Friday, those chronic, lingering problems got acute in a hurry when the Third Avenue Focused Credit Fund imploded. And the real risk is that things only get worse from here.
|A sick market has a lot of people worried.|
Why? Because excessively low interest rates, and repeated rounds of global QE by central banks, helped inflate a huge bubble in junk bonds. Too many investors who were too desperate for income bought too many mutual funds, ETFs and individual high-yield bonds.
Total junk debt outstanding soared from just $940 billion in 2008 to more than $1.8 trillion this year, fueled by record-high issuance over the past half-decade. Junk bond mutual funds attracted record net cash flows of $55.6 billion in 2013, on top of $34.3 billion in 2012 and $21.6 billion in 2011, according to the Investment Company Institute.
Now, a huge amount of the money that dog-piled into these higher-risk investments in a desperate search for yield is draining right back out. Bank of America (BAC) estimated that investors yanked $3.8 billion from junk bond funds last week alone.
The iBoxx High Yield Corporate Bond ETF (HYG) traded a whopping $4.3 billion worth of shares on Friday, the most since inception in 2007. This Bloomberg story has even more fascinating statistics about the carnage in HYG — including the fact it had its third-worst day of outflows on record ($560 million).
Bottom line: I don’t think the sick stock market is going to get any help from junk bonds. Instead, I think it could get even sicker in the weeks and months ahead.
|“The sick stock market isn’t going to get any help from junk bonds.”|
So don’t forget my recommended strategies: Raise cash. Buy inverse ETFs to hedge your downside risk. And for your more aggressive funds, turn this into one heck of a profit opportunity (more details a bit further down). Many financial stocks are particularly exposed to weakness in credit, including private equity firms, fund management companies, Wall Street-focused banks, and large foreign financial institutions.
Now let me hear your thoughts. Is $3.8 billion in outflows just a taste of what’s to come? Or are junk bond investors selling at the wrong time? Are stocks going to be hostage to junk bonds for the foreseeable future? Or is this trend played out? Any particular stocks or sectors you want to avoid or buy here, given what’s happening in the markets? Post your comments online.
Many of you took the opportunity late last week and over the weekend to discuss the junk bond market turmoil, and what it means for stocks down the road.
Reader Donald L. said: “Third Avenue had a good reputation and this comes as a bit of a surprise. But it offers a good lesson for all. Some junk bond funds and ETFs will fall, but will also recover later as they don’t have quite this level of eclectic junk.
“The whole idea of a fund is to provide some sort of cushion against everything but total failure. The reckless use of leverage and exotics violates this principle. One would hope, but I doubt, that a painful lesson has been learned.”
Reader Chuck B. added “I agree with Mike that it is a shocking development, but it isn’t totally unexpected. If not that fund, it would have been another one. Others are likely to pop up.
“What worries me is the effect it could have on even higher grade bonds, and, after a bit, on the stock markets. So many companies – even quality companies – have gone into the debt market to finance expansion and capital expenditures, and these could be in danger of having their debt downgraded. Would investors want to own companies that have had debt downgraded? Even sound companies could see their stock move lower out of caution.”
Reader Billy was even more emphatic about the dangers ahead, saying: “There are innumerable canaries in the financial coal mine and the high-yield junk bond market is NO exception. It ranks as one of the largest canaries in the world’s financial markets. Katy bar the door … the bear market is about to really roar!”
When it comes to investing in higher-yield investments in general, Reader Jack M. had this to say about one category of them: “I’m experiencing pain on some energy pipeline stocks. Just when I thought it was low, it went lower. Seeing the dividend go up made me feel better. As long as I have confidence the investment will survive, the yield will cover the losses. In income investments, I like to think long term. Am I crazy?”
In response, Reader Jim said: “I have three of them myself. It’s been very painful. I ask myself if all of a sudden, an important element of our infrastructure is trash. I don’t think so. I think it’s mostly related to credit market problems discussed here.
“KMI, for instance, is the prime dry gas mover, which has a bright future. Rich Kinder is one of the best at what he does. If and when we start exporting gas, it should do a great business. I agree, a long-term strategy is the right one. I’m sticking!”
Lastly, Reader Lois said: “Do your subscribers a favor and recommend how to benefit from junk bond failures through such vehicles as Inverse ETFs, etc.”
I appreciate all the comments. I have been watching the junk bond market for many, many years and I know that ultimately, what happens there always spills over into stocks. It’s been clear over the past year that the junk bond weakness didn’t bode well for equities.
It’s also why I have advocated several strategies for coping (raising cash, using inverse ETFs to hedge stock risk, targeting vulnerable companies with put options for your speculative funds, etc.) here in Money and Markets.
(Editor’s note: In answer to Lois’ question, Mike has given multiple recommendations over the past several months in his Interest Rate Speculator service designed to help subscribers profit from junk bond-driven turmoil. Several positions have delivered double-digit or even triple-digit profits.)
If you have other questions or comments on these topics, make sure you add them below.
Newell Rubbermaid (NWL) is buying Jarden Corp. (JAH) for $13.2 billion, uniting two makers of consumer products. The combined firm will sell everything from Cephalon kitchen products to Aerobed mattresses to Graco strollers.
The CEO of the mutual fund firm Third Avenue Management, David Barse, has been let go. He ran the firm since 1991, but was fired after the Third Avenue Focused Credit Fund was locked for withdrawals. The move rocked the high-yield debt market last week.
Speaking of casualties from falling junk bond prices, Stone Lion Capital Partners L.P. said investors couldn’t withdraw money they had invested in its credit-focused hedge funds. The firm manages around $400 million in those funds. The real irony here? Stone Lion was founded in 2008 … by two veterans of failed brokerage Bear Stearns & Co.
Will the Federal Reserve hike interest rates on Wednesday, only to turn around and cut them back to zero later on? The Wall Street Journal explored that possibility in a story today.
Recent experience in other countries suggests that’s a possibility, as does the threat of yet another asset bubble bursting. We’re already seeing junk bonds implode, and the story discusses whether commercial real estate could be next.
So what do you think about these firms preventing investors from getting their money back? How about the Fed – what are you expecting officials to do this week? Any other topics I haven’t covered here that you’d like to weigh in on? Then use the website as your outlet.
Until next time,
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