Are you an investor in American junk bonds? Prepare yourself in the eventual pop in the junk bond bubble.
According to a research note by UBS Group AG credit strategists Matthew Mish and Stephen Caprio (via Bloomberg News), a slowdown in United States economic growth could prompt the bubble in junk bonds to explode. And this won’t bode well for many companies and investors.
The financial experts say that investors that lend to American junk-rated firms aren’t being compensated for the potential credit risk that could prompt defaults to reach record highs. With unattractive firms accounting for about half of the junk bonds, investors that dived into this market could experience substantial losses.
“There is a bubble in speculative grade credit. Simply put, clients were not being compensated for the credit risk,” the credit strategists opined. “We believe roughly 40% of all issuers are of the lowest quality, and roughly $1 trillion which will end up ‘distressed debt’ in this cycle. Much of the debt was bought to pick-up yield linearly, but the default risk is exponential.”
What’s interesting about this report is that they noted many of these same companies should have folded during the economic collapse. However, they’re still maintaining operations due to easy money policies perpetrated by central banks, such as limited credit losses and cuts in borrowing costs.
Nevertheless, it’s only a matter of time before the most vulnerable firms implode.
“This leaves firms more vulnerable to peaking profit margins, rising interest costs, tighter capital markets and a slowdown in U.S. growth,” the strategists wrote.
And, what’s worse, investors aren’t ready for the coming crisis.
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