What goes up (bond prices), will go down. What goes down (bond interest rates), will go up. That is David Stockman’s warning.
Corporate bonds are the financial IEDs (improvised explosive devices) of monetary central planning. The Fed’s sustained, heavy-handed financial repression has generated the greatest ever scramble for yield, and it is now entering its seventh year. Consequently, speculators and bond fund managers are all in the same side of the boat. And all but the most intrepid traders are scared to death to short the Fed, fearing that any day it might uncork yet another round of bond market repression.
So we have basically a highly artificial one-way market in corporate bonds—both investment grade and high yield. Very recently yields in the latter touched an all-time low of 4.87%, meaning that after inflation and taxes there is virtually no room for losses on securities that are called “junk bonds” for a reason. Likewise, the investment grade index yield is down to 2.97%, leaving almost no margin for risk relative to the allegedly risk free rate on treasuries.
What this means is that the $5 trillion corporate bond market is badly mispriced. Yet history proves time and again that sub-economic yields do not stay that way indefinitely. Eventually the normalize—either because the Fed finally cools down its printing presses or owing to an unexpected shock, such as a surge of inflation, that triggers a sell-off.
It’s not a matter of “if.” It’s a matter of “when.”
A slow economy drives corporate bond rates down, which is another way of saying it drives bond prices up. The sagging economy shows no signs of recovering. The 2.9% annual decline in GDP in the first quarter is evidence that the recovery is on life-support. This keeps bond prices high. This raises the question of timing. Stockman’s concern is not at the top of most investors’ list of concerns. But the long-run implications are ominous. The investing public will suffer a day of reckoning at some point — and for decades thereafter.
When it comes to long-term corporate debt, this rule is true: “Things are easier to get into than out of.”