Corporate Bondholders Could Be At Risk If Yields Rise | ETF Trends

While most investors have been fixated on government bond yields and an inverted yield curve in Treasurys, unprecedented high corporate debt contaminates the bond market, the stock market, and the broader economy, according to several respected analysts.

Stephanie Pomboy, founder of economic consulting firm MacroMavens, who correctly prognosticated the dangers of the impending subprime mortgage crisis, which led to the general financial crisis that followed in 2008, now sees troublesome similarities in today’s debt markets.

“In 2007, the lie was that you could take a cornucopia of crap, package it together, and somehow make it AAA. This time, the lie is that you can take a bunch of bonds that trade by appointment, lump them together in an ETF, and magically make them liquid,” Pomboy said in an interview for a column in Barron’s.

Fixed income instruments that carry little to no yield

Investors these days are facing enormous quantities of fixed income instruments that carry little to no yield. Estimates of sovereign debt in that category put the total in excess of $15 trillion, a value that has been rising over the past several years, as central banks hammer interest rates to zero and below.

The problem occurs when interest rates rise even slightly, as rates and price gains run inversely, posing a potentially dangerous threat, especially if market changes direction and bond holders seeking price gains rather than yield are trapped with untenable risk.

“The interest rate risk that these bonds carry is huge,” Bianco said in a recent interview. “The financial system doesn’t work with negative rates. If the economy recovers, the losses that investors would take are unlike anything they’ve ever seen.”

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This could become a problem overseas, where in Switzerland for example, there is a sizable amount of negative-yielding corporate debt. If yields on Swiss bonds go up just 2 percentage points, Bianco explained, it would amount to a 50% loss for holders, which would be catastrophic for institutions.

“We continue to think there is a wall of new money being forced into the global corporate bond market,” Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch said in a recent note to clients. “The trigger is lower interest rate volatility or simply the passage of time, as a lot of foreign investors are being charged (negative yields) for being underinvested.”

Investors looking for alternatives to bond debt could consider a high dividend paying ETF like the Vanguard High Dividend Yield ETF (VYM), which holds well-known companies like Johnson and Johnson and Exxon Mobile Corp.

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