Today marked the 13th consecutive day of positive HY fund flows (bringing total to $8.6bn)…
But as Credit Suisse explains, the nature of this demand is 'different'…
Investors likely using the ETFs as a placeholder for cash in the absence of new supply, with HY issuance down ~74% year on year.
With ballooning ETF inflows the past few weeks, the liquid sector has become increasingly vulnerable to ETF cash rotating out upon the availability of new supply.
This is particularly a concern now as the visible issuance calendar for the next few months has grown sizeably (~$35bn)
So put another way – given that the calendar is set to pickup, this huge inflow of 'placeholder' cash will flow out of high yield ETFs (pushing prices lower) and into the new issuance.
But, as Edward Altman warns Goldman Sachs, however, that we are already at the end of the benign cycle or nearing it.
We are in the bottom of the 8th or 9th inning, and unless the Fed steps in to add liquidity to the market, which seems unlikely, I don’t expect extra innings.
I define a benign cycle as having four ingredients:
- default rates below their historical average,
- relatively high recovery rates in the event of defaults, making the loss given default low,
- low yields, giving borrowers incentives to utilize debt financing, and
- ample liquidity. Liquidity is difficult to measure, but in benign cycles, firms of almost any credit quality are able to borrow easily.
Looking at those four factors, three are pointing toward the end of the benign cycle. Recovery rates are below their historical average, mainly driven by the oil and gas sector. Spreads are above their historical average—currently around 750bps in high yield vs. a historical median of about 520bps—meaning that investors are no longer providing capital at cheap rates; and liquidity is much more restricted than even a few months ago, with the marginal company having all sorts of problems raising capital at low interest rates. The only indicator that isn’t implying a complete end of the cycle is the default rate on high-yield bonds or leveraged loans, which remains below the historical average. However, it is climbing and—according to my forecast and most economists and market observers—likely to rise above the historical average this year for the first time since 2010.
Therefore, by just about any metric, the benign cycle seems to be over, so we are entering more of a stressed cycle. We are not yet at point of crisis or distress, though, and it remains to be seen whether we will get there.
And the bubble has plenty of room to burst…
To some extent, this bubble reached a high point in the third quarter of 2015. Starting in the fourth quarter, new issuance dropped and very risky companies, B- and CCC companies with very low Z-scores and very high yield spreads, were no longer able to raise money at almost any rate. As a result, new issues since then have not been as poor in credit quality. But the bubble is still sitting there—even if it isn’t getting bigger—and is pretty inflated, though not necessarily ready to burst unless we have a recession. People say that as long as the economy remains relatively robust, we don’t have to worry about a bubble. I am not quite as confident. But if we do have a recession in the US or a very major downturn in China in the next 12-18 months, there is no question that the bubble will burst, resulting in a mini or not-so-mini credit crisis.
And the corporate bond market is not small…
Recent improvement notwithstanding, IG and HY net leverage ratios remain above the medians of the last three decades… and high yield bond spreads have not traded at these levels outside of a US recession…
And even with recent strength, levels remain extreme…
via Zero Hedge http://ift.tt/1SoIAJG Tyler Durden