“$1.6 Trillion in Defaults Coming,” Legend Says

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By Dr. Steve Sjuggerud, Daily Wealth:

Martin Fridson is – without question – the biggest name in his field. (He has been for decades.) Right now, he’s extremely concerned. Last week, he shared his big concerns at our investment conference in the Dominican Republic.

Fridson rules the world of speculative bonds. In his presentation, he showed how high-yield bonds are just as good an investment (if not better) than stocks – during normal times. But times are not normal today… and Fridson is worried. He sees “the next junk-bond implosion” arriving as early as 2016, and lasting through 2019.

In Fridson’s base case (not his pessimistic case), he sees $1.6 trillion dollars in total speculative bond defaults over the course of the next junk-bond implosion.

Interest rates have fallen so low in America that investors have been “reaching” for yield. They have been buying much riskier investments, just to get a bit more interest to live on. And that’s dangerous. Fridson’s base case is built relatively simply, based on historical cycles in high-yield bonds, and based on reversion to the mean over the long run. He explained this on Stansberry Radio last month:

Right now the yield on the high-yield index is right around 6%. The long-run average on that is more like 9.5%… I think over five years, that it’s a very strong likelihood that we’re going to be back up to at least average levels at some point. So as the yield goes up, the price goes down, and that cuts into your return… If you just look at historical experience, you’d actually expect a slightly negative rate of return over the next five years.

People are buying high-yield bonds today, expecting to earn 6%. They are not expecting to lose money. But if interest rates rise eventually on high-yield bonds – as Fridson expects – these people will lose money. Fridson expects that – in the worst of it – the interest rate on high-yield bonds will soar to more than 10 percentage points above Treasury bonds. Remember, bond prices go down when interest rates go up – so investors will lose a lot of money as that happens.

Right now, there are barely any storm clouds on the high-yield horizon. The default rate on speculative bonds right now is about 2%. But this number is cyclical as well – and Fridson expects it will peak above 8% at the worst of the next junk-bond implosion. Fridson doesn’t expect the danger to start tomorrow. His forecast for the next junk-bond implosion is from 2016 to 2019.

Will he be right? I don’t know. Predicting the future of financial markets is near impossible. But who could make a better guess about the future of high-yield bonds than Fridson? In my opinion, nobody. And he is predicting $1.6 trillion in defaults. You don’t want to be holding the bag when that happens.

We can’t know the future, but if you’re thinking about investing in an income investment that is a bit riskier but pays a higher yield, I would think again. Instead, I suggest you heed Martin Fridson’s advice and start to steer clear of high-yield bonds, particularly from 2016 to 2019. By Dr. Steve Sjuggerud, Daily Wealth

Warren Buffett’s impeccable sense of timing appears to have kicked in, but he didn’t want to spook the markets. Read… Buffett Is Dumping Stocks out the Backdoor

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  7 comments for ““$1.6 Trillion in Defaults Coming,” Legend Says

  1. VegasBob
    Nov 18, 2014 at 1:53 am

    Up on deck for default is Caesars Entertainment, the huge casino operator.

    Rumor has it that Caesars will file a “prepackaged bankruptcy” restructuring on January 14, 2015.

    This may be the one that opens the floodgates…

  2. mick
    Nov 18, 2014 at 3:47 am

    2016? More like 2015. After so many failed predictions the last 5 years, everyone now builds a buffer into them, just for good measure.
    And 8% won’t even come close to the actual default rate once this gets going. You’ve got companies like Philip Morris that have no shareholder equity left, complete shells waiting for any wind of change to blow them over like the house of cards they are.
    Nevermind the less credible companies. It’s so much worse than people know.

  3. Mike R.
    Nov 18, 2014 at 5:09 am

    Why does everyone think interest rates are going up? I think they will go down from here. The world economy is declining. The US economy is running on the the remnants of cheap QE money. Once the current pipeline of development builds out, there will be nothing. And once word gets out that all these apartments being build have huge vacancy rates, things will not seem so good.

    There is no way the US economy will continue at current levels without some form of significant stimulus. The Fed will be very reluctant to start another QE and is trying to place the burden properly on the government (e.g., fiscal stimulus). But there we have the perfect storm set up with Republican Congress and Obama in WH such that nothing will get done along these lines.

    The economy will continue to tank until/unless either the Fed of Congress/POTUS blinks. In either event, I don’t see interest rates rising. The US 10 year has lots of room to move down to area of Japan and Europe. And I think it will do so.

    All the Fed’s posturing about raising rates is nothing more than attempting to make people think that THEY think the economy will continue to heal and we will be back to normal times. THEY don’t really believe that but they have to make it look like they do.

    • economicminor
      Nov 18, 2014 at 10:30 am

      The raising rates could happen as the economy declines. If/when companies like Phillip Morris, Caesar’s and et al debt collapses the bond holders will lose most or all their investment dollars. If this truly is a beginning of a trend, whereas revenues are insufficient to continue to keep up the farce of profitability, then risk will have returned to the market place thus interest rates will again be a factor in assuming risk.

      If companies are unable pay their overhead costs including their debts due to low revenues, there will come a time when lending them more money will be extremely high risk. Unless the FED is willing to lend to them directly, or give them money directly, then rates could be low for things the FED can directly affect but not for really high risk bonds. The problem I see is that if/when this happens, it will take the entire economy down with it as the amount of leverage in stocks is very high.

      This may seem incongruous with today’s imaginary economy where anyone can get cheap money but once defaults start due to low revenues things should change rapidly. I say should because who knows, the FED may decide to just bail out companies rather than allow the economy to deflate. As none of this has ever actually happened here before 2009, there is no history to see how crazy our version of Command and Control Central Planning will go before it does what others before it did, collapse from its inability to understand or extrapolate consequences. Both China and the USSR went thru these phases of central planning and control and both failed. I assume our version will also fail. I just haven’t any idea when or how this will actually unfold. A collapse of what should have been high risk investments sure sounds like a good possible scenario.

  4. Julian the Apostate
    Nov 18, 2014 at 7:15 am

    Vegas Bob is right on. As we saw earlier Atlantic City is in trouble as well. When the purveyors of vice can’t even break even we are in trouble. The Bulls are like the little girl digging through the manure pile. When asked by her father what are you doing, child? The youngster replies ‘with all this manure around there has to be a pony in here SOMEWHERE

    • VegasBob
      Nov 18, 2014 at 4:08 pm

      I used to be an executive with one of the big casino companies but I retired and moved away from Vegas some years ago. When I visit Vegas now it reminds me of a Burger King with ashtrays.

      The fact is that Las Vegas has never completely recovered from the financial crisis of 2008-2009. So my view is that the so-called ‘economic recovery’ of the past 5 years is just a gigantic hoax.

      I agree with Mike R. and think interest rate will decline further. Rising rates would bring about the collapse of all the asset classes the Fed has worked so hard to inflate – stocks, bonds, housing, and the banks’ quadrillion dollar derivatives bubble. Therefore, the Fed will do anything and everything it possibly can to prevent rates from rising.

      At this point, the only thing left on my bucket list is to live long enough to watch the implosion of this financial house of cards that the Fed has built over the past 6 years. I really want to live long enough to watch that collapse happen.

  5. Julian the Apostate
    Nov 20, 2014 at 3:27 am

    ‘Nuff said

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