“Junk” Is Hot Again — Despite Warning Signs

Default rates of low-grade corporate debt are rising

By Elliott Wave International

The demand for junk bonds is running high among global investors — again.

As the Wall Street Journal noted on June 9:

Europe’s riskiest corporate debt has rallied to pre-crisis levels.

Elliott Wave International’s July Global Market Perspective, a monthly publication which covers 40-plus market worldwide, showed this chart and said:

The Bloomberg-Barclays Pan-Europe High Yield Total Return Index has retraced nearly 80% of its prior drop. Accordingly, the spread between European junk bonds and government debt narrowed to its lowest level since March 6, 2020. “When deals have come in the high-yield market in Europe, they have been well received,” notes one credit strategist with JP Morgan Chase.

Yet, here’s what’s noteworthy: Global investors are swooping up risky corporate debt despite the fact that they’ve been warned of possible impending hazards.

As the July Global Market Perspective goes on to say:

[A] symptom of pervasive complacency is that investors are snapping up junk bonds despite a widespread understanding that default rates will skyrocket. According to estimates by S&P Global, the default rate for European speculative-grade corporates will hit 8.5% by March 2021, a three-fold increase from today’s rate. In the United States, Moody’s Investors Service expects the trailing 12-month default rate to hit 11.1% by March 2021. Goldman Sachs puts the percentage higher still — at 13% before the end of 2020. More important, default rates are rising despite the concerted attempt by worldwide central banks to backstop the market. In April, the U.S. Fed began to purchase the debt of so-called fallen angels, which are companies that lost their investment-grade rating during the pandemic. The European Central Bank is about to follow suit. In June, ECB official Olli Rehn told reporters that he was keeping an open mind about implementing the same policy.

Junk bonds are issued by companies with the weakest balance sheets. Investors’ claim on assets in the case of bankruptcy is usually next to the bottom rung, one notch above equity holders.

But, because the trend in junk bonds often aligns with the trend in equities, when stocks rise, indicating increasing appetite in “risk assets,” so do the prices of junk bonds.

Of course, this also suggests that junk bond investors everywhere should be highly interested in the trend of global stock markets.

Elliott Wave International’s analysts also cover other financial markets and economies worldwide.

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