Wolf here: This comment by VegasBob on my article, Junk-Bond Turmoil just Preliminary, “The Real Panic Will Come With…” nailed it. It describes what happens to junk bonds you have in your portfolio – or stashed away in bond funds – when liquidity dries up, rates rise, and spreads rise. It’s a real predicament. The mainstream press rarely discusses it. The losses, even this early in the stampede out of junk, assuming you can sell it all, can be steep. Here it is:
Yes, liquidity in the junk bond market has more or less dried up, and prices are plummeting.
I have one 10K junk bond left in my portfolio.
It was at 83 in the beginning of May, when I should have sold it; now it’s down to 51, and trying to catch a bid for it is harder than pulling hens’ teeth.
I tried to sell it on Tuesday. My broker put out a ‘bid-wanted’ request that came back ‘no response,’ meaning not one dealer in the country was willing to buy it.
My thought is that what’s coming down the financial pike is going to be much worse than 2008.
For the article and the rest of the comments, click on the link above.
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Hi Wolf,
I thought I’d give you an update.
First, my broker is one of the large national brokers; not a small regional or independent broker, so a ‘no bid’ on a bond is significant.
I haven’t tried to get another bid on the bond after the failed bid request. However, later in the week, someone did sell 90K of that bond to a dealer at 45.
So if I can unload it, it looks like I’ll be lucky to get 45 on a bond that was trading in the low 80s just 3 months ago.
Anyhow, if I try to sell the bond again, I’ll give you an update.
The plot thickens! Looks like you’re going to have to take a major hit on that thing. Thanks, VegasBob, for keeping us posted.
Other option is to wait it out, until one of two things happen: maturity approaches or the company defaults. In the first case, you’re likely to get most or all of your money back; in the second case, you might lose all of it.
Great writing Wolf.
May I kindly add that there is a 3rd option:
If you wait long enough, you can bet your stars that Fed Yellen will dip into the vat of toxic QE just one more time.
When that time comes, ALL THE MARKETS will be flooded with US currency.
For a second or two, those bonds may go back up to the ’80s
Crack up Boom coming !
Right Ahead !
B
I would expect selling now during terrible news would get you a very low price. I only buy junk bonds that I plan to hold to maturity, so I haven’t experienced the discounted selling process. In the past, if I wanted to stay liquid, I would buy junk bond funds during terrible sell-offs at a discount and see them rise later.
One way to make that buy/hold/sell decision: attach a probability of default to that bond. So in simplified form: if you assume that $10k bond has a 25% chance of default where you would lose 100%, and a 75% change that it would survive to maturity, you would attach a value of $7,500 to it. If your best offer is $4,500, you hang on to the bond (or buy more at $4,500). If someone offers over $7,500, you take the money and run.
In that sense, you’re lucky you own the bond and not a bond fund.
The article was about bond funds. Owners of a bond fund get hit when the fund experiences a run in a down climate and HAS to sell its illiquid holdings. These losses are permanent. And they’re steep. Hedge funds are often on the other side of the trade and make a killing, based on the above calculation.
How far do you think yields for junk bonds will climb, before the risk is worth it?
Also do you think investment grade bonds will take a hit or see much of a yield change from this, or will we have to wait for rates to be raised before investment debt yields start to climb?
I read so far in august around 50 billion worth of bonds have been sold. Lower in july but didn’t seem too far out of the ordinary. But am curious if any real effects will be seen like during the taper tantrum.
A junk bond (or any corporate bond) is only as good as the company issuing it. So to value a junk bond and get a feel for the probability of default – and the extent of the loss in the event of a default – you must vivisect the company. That’s often hard to do, with the limited publicly available info.
That’s why few retail investors get into that game.
Of course, you could always take a leap into the dark and hope for the best.
But one thing is already going on: default rates, though still low, are rising. So that leap into the dark could end with a very painful landing.
Well there goes my dreams of easy profit :).
I was thinking though of the mortgage crisis, where rates went higher after a lot of home purchases and some people blamed that on the higher default rate.
Was wondering if that could happen again with people exiting the bond market and rates going higher. Just cause more defaults to happen.
My worst thought is that many defaults would cause enough job losses to hurt the economy. Especially with prime corporations taking on more debt, could be hard for them to do well.