Junk bonds might be a topic that comes up frequently in 2018. Let’s get out ahead of the pundits with some analysis and implications.
Over the past year junk bonds have formed a large rounding top. Often times we see these type of patterns actually break higher. We can look to transports in 2012 or oil last year. That said, it’s a potential top until it isn’t. If global long term bond yields start to break out, it’s hard to see this completely bucking the trend.
The narrative could get spooky if junk bonds do head lower. For years now, covenants have been slashed as large funds have been indiscriminate buyers chasing yield. Moody’s Covenant Quality Indicator is at all time lows. Meanwhile, 10% of corporations in Europe are don’t have the earnings to pay off their debt interest. Make no mistake, eventually that will matter.
It’s important to note that while junk bonds breaking down is always negative for the market, often times it takes time to actually impact the market.
The most recent example we have is in 2014. Junk started to lag long term treasuries and saw a major price breakdown as well. The market didn’t roll over until mid 2015.
Of course every scenario is different, but this is just illustrating the point that doom won’t necessarily come today, tomorrow, next week or next month if junk bonds start to break down.