Junk Bonds Price Warning

The unwatched pot set to start boiling first...

 

SO IN the latest 'event', the ECB did nothing, writes Dan Denning in his Daily Reckoning Australia.

 

The next time the European Central Bank does something, it will have to be unconventional. It could be another Long Term Refinancing Operation (LTRO) – that's a complicated way of describing a debt restructuring. You never really pay off large government debts under that strategy. You just refinance them with a later maturity and leave the problem for somebody else to deal with.

 

This concept of forever putting off the day of reckoning brings us back to the point where we left off yesterday. It also relates to the point where we began the week, that there's a dearth of quality collateral and real capital in the world. What does a Welfare State with unsustainable finances do when faced with the reality that it can't pay for the promises it's made without mountains of new debt?

 

Well, the sensible answer is to make fewer promises and, as a society, start living within your means. It would also help if the transnational progressives who've never run a business in their life quit trying to turn everyone into a dependent of the State. But this kind of reform rarely comes from within. It's always imposed by external events.

 

Bankruptcy is one of those events. But a one-time 10% wealth tax on the value of your assets is already under serious discussion by the International Monetary Fund. A bail-in is just another way of describing a bank robbery. It's an inside job, and it's done with a few keystrokes instead of a loaded gun. But it's robbery all the same.

 

Our point? Things that are demographically, mathematically, and logically unsustainable can be sustained for an awful long time, provided you have enough belief and plenty of paper and ink for your printing press.

 

The printing press requires the political will of elected officials to use it? Check. The belief comes from a financially illiterate citizenry that mistakes paper money for real wealth? Check again.

 

But, if markets still matter, if they haven't been completely tamed and perverted by the occupying powers from Washington and Wall Street, then you'll see 10-year US interest rates rise this year. Of course everyone's watching the 10-year rate. If you're looking for a pot that will boil first, while no one is watching, try the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK).

 

This ETF tracks an index of non-corporate, non-investment grade, US Dollar denominated debt.

 

The first thing you'll notice is that this proxy for junk bonds launched in late 2007, before things really went to pot. Wall Street has impeccable timing when it comes to offering people high risk products at the worst possible time.

 

Beyond that, the stability of the index is what's most remarkable. The suppression of interest rates has 'smoothed out' what are normally much more volatile prices for junk bonds. Even the total gain of over 120% since the 2009 bottom isn't all that flash, especially since blue chip stocks have done better. But that's the point, isn't it?

 

Prices aren't really telling you much about risk these days. But if price signals do start to work again, they will flash red for high risk investments. Eventually, they'll show up in rising ten-year bond yields. But before then, look to the margins for signs of real trouble.