Unique Market Perspectives is a set of charts and commentary that highlights some of our thoughts on macro trends that may impact our thoughts on individual companies or the attractiveness of the market as a whole. Last month we covered Airline stocks, the quality asset and oil markets.
This month we will cover the following topics:
- High Yield Loans
- Recession Indicators
High Yield Loans
High Yield Loans have emerged as a new 1 trillion dollar asset class in the past 10 years. Growth in this assets class has exceeded and is now catching up in size to high yield bonds, the junk bond market.
These loans are often syndicated, and in recent years, increasingly used for corporate engineering in the form of takeovers and buybacks. More ominously, the loans are increasingly being issued with weakening covenants and terms. Perhaps the market is correctly looking over the horizon at shipwrecks yet to happen.
Publicly traded markets for bonds are showing stress in the credit markets. Bank investors may wish to be concerned where bank liabilities are not yet showing stress, the marked to theoretical inventory of high yield bonds.
Perhaps the most widely watched, and believed prescient forecaster, is the treasury yield curve. As for which part of the curve, the spread between ten and two year treasury has inverted in advance of the past seven recessions.
We are, of course, dealing with a small number of samples. Also, many believe (including the Federal reserve) that the massive quantitative easing, implemented around the world around the world, has artificially lowered long term yields with a corresponding distortion in the spread, and perhaps it’s signal quality. Even with these caveats, it is useful to know that previous recessions followed an inverted yield only after an extended period of time.
The flat or inverted yield curve signals slowing growth and with the conditions for a recession available. The actual event or catalyst is typically only revealed later, according to recent research from the St Louis Fed. The proximate cause for the 1990 recession was the spike in oil prices following the Iraq invasion of Kuwait, and the causes for the 2000 and 2007 recessions were assets price collapses. None of these events were particularly easy to forecast in advance, what was possible to see was the preceding flat or inverted yield curve, presaging a slowing economy vulnerable to shocks. This view likens the current economy to a patient with a weakened immune system.
Recession Watch (part II – confidence)
If the current expansion lasts thru 2019, it will become the longest expansion in US history with 121 months. In addition to the yield curve and signals from employment, a favored forecasting tool has been the Index of Leading Indicators. The index includes 10 components for forecasting economic activity, including measures of employment, production, the stock market itself, and the yield curve.
Like the yield curve, this index has also turned negative ahead of the past 7 recessions. Unlike the yield curve, it does not appear to occur reliably in advance.
A relatively obscure indicator from the options market, might be signaling the difficulty in forecasting the onset of the next recession. Implied volatility is an estimate of the markets anticipated movement, or volatility. Th volatility of this measurement, the volatility of volatility, is an estimate of the markets confidence in its estimate. This measure shows a market very unsure of itself.
To review previous market perspectives, click the following links: