The Sovereign Society Reports: Junk Bonds Heavily Overbought Amid Tight Credit Noose

According to Sovereign Society Investment Director, Eric Roseman, Junk bonds, or high-yield bonds, have seen their yields crash since peaking in early March from 17% to just 9.3% now.

Montreal, Canada (Vocus/PRWEB ) June 16, 2009 -- According to Sovereign Society Investment Director, Eric Roseman, Junk bonds, or high-yield bonds, have seen their yields crash since peaking in early March from 17% to just 9.3% now. The index has gained 17% in 2009 – better than U.S. stocks and other segments of risky credit.

According to Moody’s, the U.S. speculative-grade default rate on junk bonds surged to 9.2% in April, compared to 8% in March and just 2% a year earlier. Moody’s, however, predicts the default rate will peak at 14.8% in the fourth quarter, before declining to 10.4% twelve months from now.

With all due respect, these are the same guys (Moody’s) that gave high credit ratings to mortgage insurers and a host of banks and investment banks with little or no tangible assets ahead of the credit crash in late 2007

Personally, I’m not so sure the default rate will peak in the fourth quarter. In fact, I’m betting the opposite will occur...

But this isn't a normal recession; we're still trying to climb out of the worst credit environment since the 1930s. This will not be a 'normal' post-war recovery because credit expansion remains anemic. More importantly, if credit to the best-rated companies remains challenging…then imagine what lies ahead for junk bond rated companies...

This group has a tsunami of refinancing coming due from now until 2014 to the tune of $950 billion dollars. If the strongest credits are still struggling to raise capital and certainly paying a premium over short-term lending rates to secure that credit, then it only seems logical that junk bond financing will struggle

In other words; there’s an avalanche of defaults coming our way in the high-yield sector – assuming the economy isn’t in a new bull market. And historically, you never buy junk bonds when the default rate is still rising; still, as default rates have climbed markedly recently junk bond prices have soared. Something is wrong with this picture.

This is still a very challenging macro credit environment whereby financing and refinancing trends have not returned to pre-crisis levels.

Yes, the government has done a good job of masking the damage and insolvency of the banking system -- including fudging the accounting rules -- but now the real economy is next on the chopping block. This will be a much harder magic trick to follow. We're nowhere near the end of this bear market in credit.

In the recent issue of my Accelerated Income I just issued a recommendation to short or bet against junk bonds – up 29% since the March low.

Moody's is wrong; the default rate will probably peak north of 20% in this cycle...just like it did more than 75 years ago.

“With all due respect, these are the same guys (Moody’s) that gave high credit ratings to mortgage insurers and a host of banks and investment banks with little or no tangible assets ahead of the credit crash in late 2007," says Roseman. "Personally, I’m not so sure the default rate will peak in the fourth quarter. In fact, I’m betting the opposite will occur..."

Historically, the default rate on junk bonds has peaked at around 10-15% in previous post-WW II recessions.

"But this isn't a normal recession; we're still trying to climb out of the worst credit environment since the 1930s. This will not be a 'normal' post-war recovery because credit expansion remains anemic. More importantly, if credit to the best-rated companies remains challenging…then imagine what lies ahead for junk bond rated companies..."

"This group has a tsunami of refinancing coming due from now until 2014 to the tune of $950 billion dollars. If the strongest credits are still struggling to raise capital and certainly paying a premium over short-term lending rates to secure that credit, then it only seems logical that junk bond financing will struggle," Roseman continues. "In other words; there’s an avalanche of defaults coming our way in the high-yield sector – assuming the economy isn’t in a new bull market. And historically, you never buy junk bonds when the default rate is still rising; still, as default rates have climbed markedly recently junk bond prices have soared. Something is wrong with this picture."

"This is still a very challenging macro credit environment whereby financing and refinancing trends have not returned to pre-crisis levels."

"Yes, the government has done a good job of masking the damage and insolvency of the banking system -- including fudging the accounting rules -- but now the real economy is next on the chopping block. This will be a much harder magic trick to follow. We're nowhere near the end of this bear market in credit."

"In the recent issue of my Accelerated Income I just issued a recommendation to short or bet against junk bonds – up 29% since the March low."

"Moody's is wrong; the default rate will probably peak north of 20% in this cycle...just like it did more than 75 years ago."

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