Stock Market Is Missing the Warning From Junk

Junk bonds are headed for their first annual loss since the credit crisis, reflecting concerns among investors that a six-year U.S. economic expansion and accompanying stock-market boom are on borrowed time.

U.S. corporate high-yield bonds are down 2% this year, including interest payments, according to Barclays PLC data. Junk bonds have posted only four annual losses on a total-return basis since 1995.

The declines are worrying Wall Street because junk-market declines have a reputation for foreshadowing economic downturns. Junk bonds are lagging behind U.S. stocks following a debt selloff in the past month. The S&P 500 has returned 3.6% on the year, including dividends.

Adding to the worries are signs that the selling has spread beyond firms hit by the energy bust to encompass much of the lowest-rated debt across the market, potentially snarling some takeovers and making it difficult for all kinds of companies to borrow new funds.

In the fourth quarter of the year, there has been a “meaningful disconnect between equities and high yield,” said George Bory, head of credit strategy at Wells Fargo Securities. “It’s a warning sign about the potential challenges in the economy.”

High-yield bonds pay high interest rates, typically above 7%, because the heavily indebted companies that issue them are more likely to default. Investors flock to the debt in boom times when other securities pay minimal interest and often dump it just as quickly when they get nervous, making junk bonds a bellwether for risk appetite.

Defaults are rising after several years near historically low levels, as new bond sales stall and companies with below-investment-grade credit ratings struggle to refinance their debts.

The junk-bond default rate rose to 2.6% from 2.1% this year and will likely jump to 4.6% in 2016, breaching the 30-year average of 3.8% for the first time since 2009, said New York University Finance Professor Edward Altman, inventor of the most commonly used default-prediction formula.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments.
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Dean Popplewell