Junk Bond Guru Martin Fridson Predicts $1.6 Trillion In Defaults During Next Implosion

By Steve Sjuggerud, Daily Wealth:

Martin Fridson is – without question – the biggest name in his field. (He has been for decades.) Right now, he’s extremely concerned. Last week, he shared his big concerns at our investment conference in the Dominican Republic.

Fridson rules the world of speculative bonds. In his presentation, he showed how high-yield bonds are just as good an investment (if not better) than stocks – during normal times. But times are not normal today… and Fridson is worried. He sees “the next junk-bond implosion” arriving as early as 2016, and lasting through 2019.

In Fridson’s base case (not his pessimistic case), he sees $1.6 trillion dollars in total speculative bond defaults over the course of the next junk-bond implosion.

Interest rates have fallen so low in America that investors have been “reaching” for yield. They have been buying much riskier investments, just to get a bit more interest to live on. And that’s dangerous. Fridson’s base case is built relatively simply, based on historical cycles in high-yield bonds, and based on reversion to the mean over the long run. He explained this on Stansberry Radio last month:

Right now the yield on the high-yield index is right around 6%. The long-run average on that is more like 9.5%… I think over five years, that it’s a very strong likelihood that we’re going to be back up to at least average levels at some point. So as the yield goes up, the price goes down, and that cuts into your return… If you just look at historical experience, you’d actually expect a slightly negative rate of return over the next five years.

People are buying high-yield bonds today, expecting to earn 6%. They are not expecting to lose money. But if interest rates rise eventually on high-yield bonds – as Fridson expects – these people will lose money. Fridson expects that – in the worst of it – the interest rate on high-yield bonds will soar to more than 10 percentage points above Treasury bonds. Remember, bond prices go down when interest rates go up – so investors will lose a lot of money as that happens.

Right now, there are barely any storm clouds on the high-yield horizon. The default rate on speculative bonds right now is about 2%. But this number is cyclical as well – and Fridson expects it will peak above 8% at the worst of the next junk-bond implosion. Fridson doesn’t expect the danger to start tomorrow. His forecast for the next junk-bond implosion is from 2016 to 2019.

Will he be right? I don’t know. Predicting the future of financial markets is near impossible. But who could make a better guess about the future of high-yield bonds than Fridson? In my opinion, nobody. And he is predicting $1.6 trillion in defaults. You don’t want to be holding the bag when that happens.

We can’t know the future, but if you’re thinking about investing in an income investment that is a bit riskier but pays a higher yield, I would think again. Instead, I suggest you heed Martin Fridson’s advice and start to steer clear of high-yield bonds, particularly from 2016 to 2019. By Dr. Steve Sjuggerud, Daily Wealth

http://wolfstreet.com/2014/11/17/1-6-trillion-in-defaults-coming-legend-says/

David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

Get Access