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How Much Longer Can the Credit Market Rally Continue?

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JUNK (NOT THAT KIND)
DailyFeed
High-yield funds had inflows approaching $2 billion in July, the largest inflow since the credit market rally began in April 2009. According to Bank of America analysts cited by Bloomberg, there have been inflows of $3.6 billion so far this year, and with yield on junk bonds at nearly 8.5%, according to the bank's U.S. High-Yield Master II Index, a broad composite measure of the high-yield bond market, it's pretty easy to see why.

The conundrum for investors is fairly easy to nail down: yields on "safer" yielding fixed-income products - money markets, government bonds - are at such historically low levels investors are desperate for yield. As Bloomberg noted, yields on money market funds from banks such JP Morgan are at or below 0.25%. Good luck with that.

The question remains, however: is this a bubble in junk debt? It certainly was in 2007. One way to evaluate the prospects for default is simply to look at credit swaps on company debt. For example, consider MetLife, the largest U.S. life insurer, which yesterday sold $3 billion in bonds to help pay for its acquisition of an AIG unit, the largest of the $9 billion or so bond sales that took place. According to Bloomberg, the offering was broken into four parts ranging fro $250 million 3-year floating rate notes to $1 billion each in 3-and-a-half and 10-and-a-half year notes to $750 million in 30-and-a-half year notes. The supply was handled with ease. And a look at MetLife 5-year CDS provides a window into whether the added debt even budged the market's view of the company's creditworthiness.



Today Aflac announced it was planning to issue $750 million in debt to buy back stock. That, in a nutshell, is why the corporate issuance is important for equities. As the credit rally continues, companies are able to issue debt in order to engage in shareholder enhancement activities, such as the Aflac stock buyback. This is the company's second issuance since December, and it's nearly twice as large. Also, the spread over Treasuries with similar maturities looks like it will come in lower than the December issuance.

It's tempting to point to the reach for yield as a negative sign, yet another bubble, but as we saw with the credit rally in 2002 and 2003 in the aftermath of the dotcom crash, these rallies can last far longer than investors expect.
POSITION:  No positions in stocks mentioned.

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