There's A Lot More Junk Debt Out There Than The Credit Ratings Indicate

David Dierking

One of the things that ultra-low interest rates and billions of dollar of Fed QE is hiding is the deterioration of corporate credit quality.

The data citing rising corporate debt loads is well-documented. 

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Total debt held by large, non-financial corporations just exceeded the $10 trillion mark. Add in the debt held by small companies, family businesses and other entities, the number climbs to around $15.5 trillion. That's nearly 75% of U.S. GDP!

Perhaps worse is the fact that a lot of this debt is rated BBB and below.

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Roughly 72% of total corporate debt is rated investment-grade with the remaining falling in the junk category. The problem is that nearly 57% of the debt currently rated investment-grade is rated BBB, just one notch above junk.

If the global economy finally slips into a recession or even slows significantly enough, the markets could be facing a wave of corporate credit downgrades and defaults. Perhaps we have a better idea of exactly why the Fed is flooding the market with liquidity!

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If you look at current levels of corporate balance sheet leverage, the situation looks even worse.

According to Morgan Stanley research, a stunning 45% of investment-grade debt should be rated junk based on leverage alone.

IUSHYBBOA_chart

Add in the fact that the current risk premium on the highest-rated junk bonds is at its lowest level since 2007 and I don't see a good logical reason to own junk bonds in your portfolio right now.

How To Play This In Your Portfolio

Avoid junk bonds and junk bond ETFs.

With returns of 14-15% year-to-date and yields of 5%, investors will no doubt continue to be attracted to this group, but the current risk/reward tradeoff is incredibly poor.

I think one of the main themes of 2020 will be principal protection and preservation. It would be safe to stick with short-term Treasuries and high quality corporate bonds for income in your portfolio.

ETFs To Avoid

  • iShares iBoxx USD High Yield Corporate Bond ETF (HYG)
  • SPDR Bloomberg Barclays High Yield Bond ETF (JNK)
  • iShares 0-5 Year High Yield Corporate Bond ETF (SHYG)
  • SPDR Bloomberg Barclays Short-Term High Yield Bond ETF (SJNK)
  • Invesco Senior Loan ETF (BKLN)
  • Xtrackers USD High Yield Corporate Bond ETF (HYLB)

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Comments (1)
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ETF Trader
ETF Trader

Junk bonds are starting to look a lot like they did in 2016.


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