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More Bad News For Junk Bond Investors – Here’s What To Do

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More Bad News For Junk Bond Investors – Here’s What To Do by Tony Sagami, Mauldin Economics

Debt isn’t necessarily bad if it is used productively, but the one sure sign of trouble is if your debt burden is growing faster than your net worth.

In the case of the US, our cumulative debt burden is growing at a much faster pace than our gross domestic product, and we are taking on more debt than ever.

John Mauldin has written extensively about that brewing sovereign debt crisis, but credit conditions for corporate America have started to deteriorate at an alarming pace.

Junk bold defaults hit record levels

In just the last week, two high-profile companies, Peabody Energy and XXI Energy, filed for bankruptcy protection, bringing the junk bond defaults in April to $14 billion.

And April is not even finished yet!

junk bond investors

A whopping $16.4 billion of loans went bad in March—the fifth straight month of defaults greater than $5 billion. Overall, 21 companies defaulted on loans worth $31.4 billion in the first quarter of 2016, which is the fifth-highest quarterly default in history!

Bad corporate loans soared by 67% in Q1 2016

The three largest banks in the US—Bank of America, JPMorgan Chase, and Wells Fargo—disclosed that the number of delinquent corporate loans increased by 67% in Q1.

  •  JPMorgan’s delinquent corporate loans increased by 50% to $2.21 billion
  •  Bank of America’s delinquent loans increased 32% to $1.6 billion
  •  Wells Fargo’s delinquent loans are up by 64%, to $3.97 billion

junk bond investors

The banking industry, therefore, added $1.43 billion to the total money it has set aside to cover bad loans in Q4 2015, according to FDIC.

That may not be enough, though. Fitch Ratings just reported that the default rates for junk bonds rose to 3.9% this month, up from 2.1% in April 2015.

What should junk bond investors do?

Own junk at your own peril: Near 8% yields attract yield-starved investors, but rising defaults will wipe out those fat yields and even eat into your capital. If you own junk bond funds or junk bond ETFs… dump them before prices collapse.

junk bond investors

Remove half the junk bond risk: I consider the rising default rate to be the biggest risk, but junk bonds are also subject to the risk of rising interest rates. Rising interest rates erode the value of bonds, but there are specialty ETFs designed to remove that risk.

The WisdomTree Bank of America Merrill Lynch High Yield Bond Zero Duration Fund (HYZD) combines a long position in the BofA Merrill Lynch 0-5 Year US High Yield Constrained, Zero Duration Index with a short position in Treasury bonds to target the zero-duration exposure.

Profit from junk woes: If you agree with me that junk bonds are headed for trouble and have some risk capital, invest in ETFs designed to profit from falling junk bond prices. One such ETF is the ProShares Short High Yield (SJB), an ETF designed to gain value as junk bonds lose value.

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