ASSET BUBBLES TO EXPLODE...JUNK BONDS OF U.S

Many debates are humming around about the present slow down and its birth to the biggest recession of the world economy in the coming days. The biggest question is that how this child of recession would born and its long term aftershocks on the global economy. In my research I have been doing experiment where I have found that recession would happen from 2 ways 1) Slow down or death of manufacturing and conservative consumption which leads negligible demand of goods and services and 2) Through the burst of the bubbles of various assets classes where the impact would be like Atom Bomb affect on Hiroshima and Nagasaki.

The first bubble which is expected to burst out is the energy market bubble which has created a double affect. Slowdown of fresh investments and significant high level of Merger which would create long term monopolistic affect on the world energy market. This would sound to be a distant dream but history says that when there are collapses in particular industry or assets classes where cost of operating itself turns to be a burden over the sales price. This leads to close down of business or rather selling the same to someone and creating a monopolistic market in the long term.

Coming to asset bubbles we find currently that since early 2010, energy producers have raised $550 billion of new bonds and loans as the Federal Reserve held borrowing costs near zero.  Now when oil prices are around below $60 the cost of servicing the debt has became a question of billion dollars. Further junk bonds issued by the oil companies have grown significantly over the last couple of years. The total value of junk bonds in energy companies has reached $210 billion, roughly 16% of the $1.3 trillon junk bond market. The current low price of crude would spook investors to sell them as zero return has approached to these bonds. This figure is four times the share of 4% in energy junk bonds ten years ago. Many junk bond issuers now do not have enough revenue to pay high, if any, yields. Speculative capitals have caused the huge surge of investors to come and invest.

 The booms of the shale production have been the trigger followed with zero cost of borrowing of US would has resulted so much investments .Unemployment is also going to take toll in the nearby as low crude prices erases the profitability margins significantly. Employment in support services for oil and gas operations has surged 70% since the U.S. expansion began in June 2009, while oil and gas extraction payrolls have climbed 34%. Hence  a significant threat also boils over here for the US economy. Investors pulled nearly $1.9 billion from funds dedicated to low-rated corporate bonds in the past week. Energy companies sold $50 billion in junk bonds through October.

Bigger than the fall of Crude prices I find the bond market is under extreme threat which would create wave over the volatile currency movement in the coming days. ETF, Hedge funds would be under significant threat as stupendous outflow or redemption is going to happen in the coming days. Junk bonds has played stupendous role after the 2009.

Now lest measure the affect of the low crude prices and its junk bond market affect on the upcoming years can be measured from:

• Energy accounted for more than 15% of the high yield market, making it by far the largest industry (healthcare is the second largest at approximately 8.5%).
•  Energy accounts for approximately 11% of the U.S. investment grade market (based on the Barclays U.S. Investment Grade Corporate Index).
• The sub-sectors that are most sensitive to commodity prices – Exploration and Production (E&P) and Oilfield Services – account for roughly 4% of the investment grade market (versus approximately 9.5% of the high yield market).
• In the equity markets, energy accounts for approximately 8.5% of the S&P 500 Index.

Flight of capital has begun from the junk bonds to the secured bonds of the US treasuries. We should prepared for an currency wave and turbulence for the global equity markets as flow of capitals takes new directions. This is just one of the part of the bubbles across various asset clasess. In my next series I will be coming up with many more such threats to the global markets.

Written By Indraneel Kripabindu Sen Gupta & Hardik Bhatt.