On The Macro Show last week, a subscriber asked me about the breakdown in the high-yield debt market and how far up the ladder this could spread. The viewer’s question continued, “Are investment grade corporates at risk as well?”
My quick response: Of course they are.
Not to give too much away, but we’re working on our Q1 Macro Themes presentation right now. And we plan to show our subscribers precisely what credit looks like in a recession. Spoiler alert: It looks a lot worse than it does right now.
Growth is slowing. It’s the most glaringly obvious thing we’ve seen since the last cycle. The real problem is when investment grade bonds start to turn into high yield.
Take a look at Kinder Morgan (our Energy analyst Kevin Kaiser made an epic short call in this name to the chagrin of pumpers like Jim Cramer). The reason Kinder Morgan (KMI) is worth a look in answering this thoughtful question is that KMI has the highest leverage (as measured by debt-to-EBITDA) of any company with debt rated “investment grade” in the S&P 500.This is a key part of the short case laid out by Kaiser. It’s not getting better from here either. In fact, a lot of fund managers who own Kinder Morgan investment grade debt will be forced dump it, the junkier it gets.
That’s what happens to investment grade credits in a recession. Investment grade bonds get junkier. Our subscribers know that we handicapped this right. We added Junk Bonds (JNK) to the short side of Investing Ideas on October 9th. Since then, JNK is down over 7%. Moreover, we originally went bearish on JNK in Real-Time Alerts back in Q4 of 2014.
Where are we now?
In baseball-speak, we’re in the top of the third inning of this credit market move. In six months, we might be in the seventh inning stretch. The real problem that is accelerating this slow moving nosedive is that everyone in the business of being long junk is stuck right now. They can’t get out. Just take a look at Third Avenue.
And that’s why I’m not covering this short junk bond position. No way.