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Corporate Bond Land


I see risk-taking in corporate bonds (both investment grade and junk) as obscene.

While sitting on the runway in Newark on Friday, behind 30 planes ready to 'de-ice'- and then get in line to take off, I couldn't help but read some rather interesting articles in the New York Times, Wall Street Journal, USA Today and any other periodical I could get my hands on. But one article caught my eye in particular. I have commented for a long while about the lack of value in corporate bond land and the bubble in debt that I believe exists (please forgive me for those that think debt is good). But this one particular article, written by Henny Sender in the 'Heard on the Street Column' says it all.

The article is entitled 'Din of Roaring Corporate-Debt Market Drowns Out Growing Talk of Bubble.' I have to say that says it all. The quotes that Mr. Sender uses in this article are absolutely astounding. Many of us (yes the same old crowd-Toddo, Succo, Reamer, etc. - I apologize if I missed someone) think that there is absurd risk-taking in many parts of the investment community. Call it perception vs. reality (thanks Todd) or call it imprudence as I do. I would even have to go out on a limb (a long slim limb at that) and call it improper with OPM (other people's money'). The excuse these folks make, in my humble opinion is that they must stay invested because that is why people give you money to manage in the first place. You can even label me a perma-bear if you like. But MY job, as a registered investment adviser and contributor to the 'Ville, is to call 'em as I see 'em. And I see risk-taking in corporate bonds (both investment grade and junk) as obscene.

Risks being taken in the investment community, whether it be selling naked options for nil (thanks Succo for the time in your shop Wednesday) with unlimited downside and very limited upside, or buying corporate bonds with some of the lowest spreads ever (over risk less Treasuries) makes one wonder if there is more than one bubble percolating around us. In the aforementioned article that I read on my now de-iced plane, there were some quotes from the article from some rather astute folks that I think are worth a mention. Please see below for a sampling.
  • "The Fed hasn't done much. Overall financial conditions are much easier than in 2002"-William Dudley, well respected economist for Goldman Sachs.
  • "Risk and return are all out of whack…..People are taking the riskiest pieces of the corporate capital structure even though they are not being paid to do so"-Dan Toscano, head of loan syndication at Deutsche Bank.
  • "These conditions are like the NASDAQ at 4000….And then, rose to 5000 before correcting. As time passes, credit committees lose influence as their forecasts of imminent doom fail to materialize. It is the fate of credit people to be viewed as Cassandras"-Marc Freed, managing director at Lyster Watson & C0, a New York based fund of funds manager.
  • "We see leverage creep everywhere. We see companies with very high leverage, and they can still raise another turn of leverage when they already have business issues……In the old days, banks did not do deals for such poor companies…..Now they encourage you (the banks) to borrow more"-Daniel O'Connor, Vestar Capital Partners.

I have spent a lot of my time speaking 'directionally' about interest rates on Minyanville. Some of the time has been committed to the shape of the curve and other times to the direction of rates generally (particularly the 10 year note, which at 37,000 feet I don't know if it has broken my support levels or not-sorry no Bloomberg's allowed on airplanes). But I think Mr. Sender of the Journal has hit the nail on the head. There seems to be the same 'reckless abandon' in investment grade debt, junk debt and even emerging market debt as there is in stocks and selling naked options. Perhaps there is a 'moral hazard card' in play in ALL asset classes. Perhaps, but only for while, my friends. That cannot go on forever. Markets ALWAYS revert to the mean, or below (you don't even want to know where that is). Speaking of taking risk, how would YOU value the debt of Indonesia? In 2002, I bet they couldn't tap the credit markets at all, at any level. In fact, in July 2002, junk spreads were at an all-time high of 1,000 basis points above govies. But just yesterday, Barclay's, JPM, and UBS co-managed a two part deal that raised $2,000,000,000 for Indonesia. According to the Journal, 'the size of the 2017 and 2035 bonds was larger than the anticipated $1,000,000,000 total after the offering drew $8,0000,000,000 in orders. Yields were expected at the lower end of expectations." The yields were in the 7% range. Not to slight Indonesia, and I am not an emerging markets expert, but I would imagine that at some point down the line, a portfolio manager or two will wish they bought some other asset instead.

Peanuts, popcorn, get your free money here! That is the way I see it, although the rise in yields here and in Japan may eventually put a damper on this trend. Is there a bubble in the corporate bond market? It is hard to judge and hard to say. Is there value from my seat? Nope. I would still rather own Uncle Sam's deficit-ridden 2 year notes at 4.73%. Or two-three year mortgage backed securities in the 5.75-6.00% vicinity. One thing is for sure (as that 26 year old 2 x 4 has told me over the years) is that markets do eventually revert to the mean. To quote Keynes, "markets can stay irrational longer than you can remain solvent." So, the folks buying Indonesia's debt, or our corporates at low spreads can be rewarded for a while, there may just be a correction waiting in the wings for them.

One thing is for sure. When that correction occurs, we intend to pounce. THAT, ladies and gentleman, is how you make real money in the bond market. Please feel free to e-mail me with your comments.

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Position in various Treasuries

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