The End of the Credit Cycle

Rick Mills

Aheadoftheherd.com

 

Where’s the hot money going to go when stock markets have lost all support and junk bonds have sold off?

 

The answer is the hot money, and the slow to catch on money, will start chasing real things – commodities and precious metals.

 

Gold really has nowhere to go but up. This is going to be proven out over the next 12 months as massive credit defaults sweep across all sectors.

 

I wrote the following 6 months ago.....

"Since the wake of the global financial crisis the U.S. has seen its longest run of historically low interest rates - zero to 0.25%. Now rates are starting to rise and the free lunch is off the table. Stocks are going to feel the effects of this sudden no stimulus along with the pain of overseas earnings being brought home to a strong dollar.

A strong dollar helps Americans by making imports cheaper and curbing inflation. However a strong US$ hurts U.S. based multinationals who have overseas earnings in those very same currencies that have taken such a severe beating versus the soaring U.S.$. The dollar's surge is reducing earnings. Bringing those declining yen, pesos, dinars, francs etc. home isn’t doing any good for bottom lines, in fact it could be an earnings disaster in the making.

Junk bonds are issued by companies with low credit ratings and high debt levels – they are the higher yielding bonds with most often extremely ugly credit ratings. Investors fell in love with them when searching for yield after the 2008 financial crisis.

Junk bonds grabbed headlines in December 2015 when a rout sent prices tumbling the most in four years. Energy and energy related firms, which make up the largest chunk of the market, are trying to cope with persistently low oil prices. With the supply/demand imbalance still growing in the oil market investors are worried many will default in the coming years. The negative sentiment has crossed over and hit junk bonds and derivatives in other industries."


The article below was just published by Wolf Richter, WolfStreet.com…..

“Opportunities in Distressed Assets” as current investors get crushed

After seven years of “emergency” monetary policies that allowed companies to borrow cheaply even if they didn’t have the cash flow to service their debts, other than by borrowing even more, has created the beginnings of a tsunami of defaults.

The number of corporate defaults in the fourth quarter 2015 was the fifth highest on record. Three of the other four quarters were in 2009, during the Financial Crisis.

At stake? $8.2 trillion in corporate bonds outstanding, up 77% from ten years ago! On top of nearly $2 trillion in commercial and industrial loans outstanding, up over 100% from ten years ago. Debt everywhere!

Of these bonds, about $1.8 trillion are junk-rated, according to JP Morgan data. Standard & Poor’s warned that the average credit rating of US corporate borrowers, at “BB,” and thus in junk territory, hit a record low, even “below the average we recorded in the aftermath of the 2008-2009 credit crisis.”

 

http://www.peritusasset.com/wp-content/uploads/2015/08/HY-market-size-7-31-15.png

The risks? A company with a credit rating of B- has a 1-in-10 chance of defaulting within 12 months!

In total, $4.1 trillion in bonds will mature over the next five years. If companies cannot get new funds at affordable rates, they might not be able to redeem their bonds. Even before then, some will run out of cash to make interest payments.

A bunch of these companies are outside the energy sector. They have viable businesses that throw off plenty of cash, but not enough cash to service their mountains of debts! Among them are brick-and-mortar retailers that have been bought out by private equity firms and have since been loaded up with debt. And they include over-indebted companies like iHeart Communications, Sprint, or Univsion.

The “end of the credit cycle” has dawned upon the markets. As credit tightens, companies that can’t service their debts from operating cash flows may be denied new credit with which to service existing debts. The recipe of new creditors’ bailing out existing creditors worked like a charm for the past seven years. But it isn’t working so well anymore.

 

Rick



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