The record selloff in corporate junk bonds last week is leading some investors to fear it may presage a wider crash in stocks, John Ficenec argues in The Telegraph today.
It’s not unreasonable to think that a crash of high-yield debt prices might trigger a downward spike in stock prices. If one part of the market is mispriced, it can trigger corrections elsewhere. (The Dow Jones dipped on Thursday after Lipper reported record junk bond sales but recovered on Friday following the news).
But one of the reasons the junk bond market ended up so overvalued is surprising: Because trading in that market is still done person-to-person over the phone rather than in electronic exchanges, according to Barron’s. Traders therefore often have only a hazy, anecdotal view of the entire market.
Here is the backstory:
Until recently, demand from buyers kept bond prices high and the interest on them low. Corporations floated a massive mount of money into bonds, The Telegraph says:
Investors have placed about $US80bn into US high-yield bond funds during the past half-decade. Assets under management in European high-yield bond funds have grown from €12bn at the beginning of 2009 to €57bn (£45.5bn) in April 2014, according to Morningstar data.
The Telegraph says that “wall of money” is now pouring out again:
High-yield bond funds and exchange- traded funds reported a record $US8.2bn (£4.8bn) weekly outflow last week, according to the latest data from EPFR Global. The wall of money coming out of riskier assets exceeds the previous record single-week outflow (set during the June 2013 bond market sell-off) by about $US2.5bn. The withdrawals are also larger than those recorded at the height of the global financial crisis.
As bond prices decline in the selloff, it can hurt companies. Bond prices move in the opposite direction of the interest that they yield, so as bond prices decline the interest payments companies have to make to sell them goes up — making them too expensive for some companies to consider.
A credit crunch for companies does not augur well for their stocks, of course. The Wall Street Journal warned stocks might suffer:
Many investors this year have expressed concerns that a pullback in junk-bond prices could signal that market participants are rethinking their willingness to take risk, foreshadowing further declines in stocks and other risky assets.
Right on cue, Bloomberg reported that the market for new junk bond sales in August is slower than it was last year.
Worse, some analysts are baffled as to why it’s happening now. Barron’s adds:
“This might be the most perplexing selloff we’ve experienced in a while,” Citi strategists wrote in a recent report. “There doesn’t appear to be a clear trigger, causing some consternation among market participants.”
Part of the mystery is to do with the fact that traders are still calling each other on the phone to make sales, Barron’s says.
That consternation is reflected in an antiquated quirk of high-yield bonds: They’re still mainly traded over the phone rather than on electronic exchanges.arge banks and dealers — the primary buyers — have power to set prices they’re willing to pay for all but the smallest trades. When the selling picked up in late July, they rapidly lowered their quotes. Granted, prices in any market go down when there are more sellers than buyers, but the lack of an exchange creates additional hurdles in terms of efficiency and negotiation.
“In some ways, it’s not a real market,” says Sabur Moini, head of high yield at Payden & Rygel in Los Angeles. He says dealers remain hesitant to take on inventory of risky bonds, particularly over a weekend, given ongoing global conflicts. “Well over 90% of high yield is still a broker-to-broker market. In that way, high yield and investment grade are totally different worlds.”
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