Look to the Bond Markets to Trigger Mayhem!

The comments above & below is an edited and abridged synopsis of an article by Bill Blain

The ever-rising global stock markets don't matter; the truth is in bond markets. That's where the dam will break. The bond markets are the bubble to watch, starting with high yield.

It wasn't just banks that benefited from too-big-to-fail; most collateralized loan obligations (CLOs) did, too. The 2008 global financial collapse was about consumer debt, triggered by mortgages. We still have consumer debt crisis problems ahead; they have suffered most these past 10 years, as massive income inequality has seen them earning less while paying more for everything.

The next financial crisis is likely to be in corporate debt, and it will be a credit market analogue to the consumer debt crisis of 2008. The high yield market is the likely source.

As markets recovered, banks started lending again, and low rates forced investors to buy returns. The funds that used to buy nothing but AAAs are now buying speculative B names. The demand for assets is so great, these companies have been able to lever up, refinance, increase leverage and refinance further, at ever-faster rates.

It's been exacerbated by private equity fuelling returns through debt. As demand increased exponentially, borrowers slashed covenants, making it easier and simpler for over-indebted companies to raise more cash.

As rates rise we'll see the Toys'R'Us moment repeated on a grand scale. The rise of and fall of zombie companies that can't meet debt payments will envelop not just the rest of the credit market, but also stocks.

The realization that a crisis is coming feels similar to June 2007, when the first mortgage-backed funds in the US began to wobble. It explains why the highly levered sector of the junk bond markets struggle, and companies correlated to highly levered consumers (such as health and telecoms) are also in trouble.

Little has been fixed since the 2008 financial crisis. Ten years later, the next is bubble about to burst. Corporate debt, watch out.