Boy, oh boy.
If you weren’t worried about USD HY or about the sustainability of the bubble in credit markets more generally, then I’ve got some charts that may change your mind.
But first, just a couple of reminders here. IG has been outperforming HY for months, but remember, in an absolute sense, HY spreads and yields are still near post-crisis tights and lows, respectively.
In other words, both IG and HY are probably in bubble territory and it’s starting to feel like junk may be on the verge of unravelling. And indeed, spreads did widen a bit in August during periods when jitters about North Korea and political turmoil in the U.S. catalyzed (admittedly fleeting) flights-to-safety:
The main worry here is that corporates have leveraged themselves to the hilt in an environment characterized by an insatiable hunt for yield among investors. In order to keep the ravenous hordes sated, corporate management teams have simply met demand with more supply and in many cases used the proceeds to buy back shares in a “virtuous” loop that not only inflates the bottom line, but also boosts management’s equity-linked compensation. See? Everyone’s a winner!
Well, everyone except the people who care about the balance sheet and the extent to which it’s being leveraged in pursuit of a myopic, greed-driven agenda.
This is a dynamic that SocGen’s Andrew Lapthorne has described as “clearly nonsense.”
And even though he’s “clearly” right, central banks have succeeded in short-circuiting the cycle for the time being. That is, although we would expect spreads to widen as net debt/EBITDA ratios balloon, that really hasn’t happened.
So what happens when the cycle turns? Spoiler alert: probably nothing good.
Now let’s get to the charts (and these are all from Deutsche Bank). First of all, US non-fin corporate debt-to-GDP might as well be at an all-time high and usually, when corporate debt as a percentage of GDP starts rising above trend, defaults start to pick up:
As it happens, defaults generally rise with a lag as the curve flattens and wouldn’t you know it, the 2s10s is (basically) the flattest it’s been in a year:
As noted above, leverage is extremely elevated – even ex-energy:
Finally, look how benign an environment we’re priced for in HY:
I have absolutely no idea how any of that is sustainable and/or realistic.