Gundlach’s Warning to Corporate Bond Investors

The comments below are an edited and abridged synopsis of an article by Robert Huebscher

The problem facing the corporate bond market is excessive debt and an oversupply of bonds. A massive increase in the size of the investment-grade market and deterioration in the quality of debt indicates that the corporate debt-to-GDP ratio (leverage) has increased significantly. The corporate debt-to-GDP ratio and the spread between high-yield (junk) and Treasury bonds moved in sync from1994 until 2013, after which leveraging increased without a similar increase in spreads. As a result, both corporate and high-yield bonds are at or close to their most extreme levels of overvaluation historically.

Gundlach’s Warning to Corporate Bond Investors | BullionBuzz

With respect to investing, the bond credit rating represents the credit worthiness of corporate or government bonds. The “Big Three” credit rating agencies –Moody’s, S&P and Fitch – control approximately 95% of the ratings business. The BBB-rated market, which has the lowest rated corporate bonds, is two times bigger than the high-yield market. If low rated corporate bonds are downgraded to junk, it will flood the high-yield market. If corporate bonds were ratedbased on their degree of leverage, then 45% would be rated junk. Corporatebonds have not been downgraded because corporate bond issuerstalked about addressing debt in the future, which has kept corporatebond ratings high.

The G4 central banks’ (Bank of England, Bank of Japan, Federal Reserve, and European Central Bank) balance sheets are now shrinking, largely due to the Fed’s $50 billion per month quantitative tightening (QT). As the Fedstarted QT, the 10-year Treasury yield rose almost in sync with the Fed’s shrinking balance sheet. As a result, it’s possible that yields could go up in a recession. Moreover, the US is faced with $21 trillion in debt. With that piling up in the government’s coffers, the Treasury Department will need to get creative in figuring out how to finance it. It will have to increase the sizeof its bond auctions in coming years. Unfortunately, Treasury bonds are unattractive to foreign borrowers because of US trade policies, and because hedging costs are too high. Moreover, Treasury bonds are unattractive to domestic buyers unless inflation goes down. How will the deficit crisis be resolved? When the nation realizes that the path they are on leads to catastrophe.

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