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Junk Bonds: How Quickly They Forget
Junk bond investors aren't always the best judges of risk.
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By Jason Farkas
Wed, 13 Jan 2010 17:30:00 ET |
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Now that 2009 is almost over and most assets are in the plus column for the year, the March panic seems like an apparition. One measure of investor unease, the junk bond-to-Treasury spread, which soared during the height of the crisis, has fallen more than 75% from its high, indicating that investors are confident about corporate health.
But just when confidence and prices are high, that's when we are likely to see some serious deterioration in junk bonds.
A glance at this chart (courtesy of www.biancoresearch.com) shows that the panic of October 2008 and March 2009 was followed by the massive junk bond rally, as investors embraced risk again.
But junk bond investors aren't always the best judges of risk. Notice that even in early 2008, with the recession already underway, junk-to-Treasury spreads were near 4% -- i.e., investors were clearly oblivious of what was to come.
Now spreads are back near 4%, and one factor that might affect some of our junk bond constituents are delinquency rates. Here's the current tally:
- U.S. mortgage delinquencies have risen for its 11th straight quarter, hitting an all-time high for borrowers 60 days past due. 1 in 4 homeowners is underwater, so many of those who are past-due will be walking away. Do you think that might affect firms exposed to residential real estate, such as MBIA, RESCAP and Hovnanian? You bet.
- Auto delinquencies. According to the American Bankers Association, nearly 3% of seasonally-adjusted auto loans are 30 days or more overdue. That doesn’t sound too high, but keep in mind that we’ve had 0% financing deals since 2001. Many who could afford to pay cash simply deferred payments, putting downward pressure on the ratio. There will be some big losses once vehicles are repossessed. These delinquencies spell trouble for Ford, Hertz and GMAC.
- Consumer delinquencies. The Federal Reserve says 6.7% of all credit card accounts are 30 days or more past due, the highest rate since at least 1990. Delinquencies on home equity and personal loans are now 4.01% and 3.9%. Discretionary money that might have been spent with companies like Delta Airlines, QVC, Harrah’s and Sirius XM is going to be cut, because consumers will need to tighten their belts.
- Commercial delinquencies. The delinquency and charge-off rate on commercial real estate loans has now reached 8.74%, according to the Fed. This is the highest rate since 1993, and it will put downward pressure on prices, making refinancing difficult. This is bad news for holders or lenders to commercial real estate, such as Genworth, AIG, CIT, Starwood and Wyndham.
While we can’t be sure of the timing of another collapse in junk bonds, one is on the horizon. We said in the September 11 Weekly Insight that the “PowerShares High Yield Corporate Bond Portfolio [ETF: PHB], which tracks the Wachovia High Yield Bond Index, should reveal bearish signs if problems are truly mounting.” Since then, the ETF has ticked slightly higher, altering our Elliott wave count slightly -- but not our outlook. A break of 16.87 on the downside would likely mean that the coming collapse in junk bonds -- and a concomitant rise in the junk-to-Treasury spread -- is in full swing.
A chance reading of a book on technical analysis and the Austrian school of economics eventually led Jason Farkas, CMT, to Elliott Wave International. Prior to joining EWI Jason worked for 14 years as a futures, options and equity trader. Jason has been tutored by some of the best investment minds, including legendary trader Dick Diamond. You can read Jason's Weekly Insights regularly in EWI's intensive Currency and Interest Rates Specialty Services.
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