Friday, May 28, 2021

Bubbly Junk - And A Bit Of History

 If there is one chart that shows how bubbly the market bubble really is... it is this, from Yardeni Research:

Junk Bond Yields At Record Lows

Junk bond yield spreads are at record lows, meaning that the hunt for incremental returns over safe Treasury bonds has reached the point of desperation, where all caution is thrown to the wind. Why? Because the belief that the Fed and all other central banks will stop anything bad from happening has now achieved religious acolyte fervor.   (Notably - and IMHO very, very importantly from a geopolitical viewpoint - the Chinese central bank is not following along in the monetary madness.)

Notice how spreads historically widen sharply after reaching such lows.  Sense, and a fear of risk, are eventually always restored.  In fact, the Risk-O-Meter always swings from greed to fear.  In fact, it is NEVER “different this time”.

Just as a historical reminder... remember “financial engineering” in the years before the Great Debt Crisis of 2008-09? When such “engineers” (God forbid) had discovered how to transmute junk into AAA CMOS, CDOs, etc? They claimed they had a “formula” that would let them apportion risk into various tranches in precise amounts and - voila! - dung became gold.  

Only problem was ... the formula’s parameters were completely and entirely wrong, so when even slight problems arose the entire tranche structure became unstable and tranches went from AAA into Default in just one step! 

And why were parameters wrong? Because if they weren’t deliberately chosen at the initially erroneous values to begin with, junk would have stayed junk, making the entire tranching operation impossible. Was there malice aforethought? With billions in fees at stake? What do you think?

Find today’s parallel and you can fathom how this is going to play out..


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