A Vast Pool of Greater Fools
One of the undeclared (or only occasionally admitted) goals of the enormous monetary pumping by central banks in recent years was to drive investors toward buying riskier assets. After all, if one gets virtually no interest on savings deposits and so-called “high quality debt†– which these days comprises mainly the debt of de facto bankrupt governments – is trading at yields to maturity somewhere between absurdly low and negative, what is one going to do with the flood of money pouring forth from the central planners?
A picture from the future: Risk is rediscovered at the worst possible moment.
Photo via instagram, author unknown
Junk bonds have benefited enormously from this backdrop. As is always the case at the height of a bubble, they look extremely “safe†based on the default assumptions published by the credit rating agencies. The main reason for this appearance of safety is the fact that demand is so strong that even the silliest stuff has no trouble finding a fresh batch of greater fools willing to throw money at it. In other words, it is very easy to refinance maturing debt. In this respect, junk bonds are an excellent mirror of bubble conditions: Just as most of the profits reported by companies during a credit-driven bubble are really capital consumption in disguise, the assumed safety of junk debt masks growing underlying risks. A small preview of what happens when these risks materialize is currently enjoyed by investors in energy-related junk debt – incidentally one of the sectors with the greatest amount of debt issuance in recent years. This has affected the overall performance of junk bonds rather noticeably:
The unadjusted price of junk bond ETF JNK (the adjusted version adds interest payments to the price performance chart. The adjusted version mirrors the ETF’s total return and looks a lot better of course, but the chart is also not as informative) – click to enlarge.
