What To Do With Your Junk Bond ETFs As The Bubble Grows?

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December 10, 2012 11:06pm NYSE:HYG NYSE:IYR

Mike Larson: I’ve never been one to mince words when I see dangerous bubbles inflating. And I’ve never been afraid to really ramp up the volume of my warnings when I feel the top

of a speculative bubble is getting close.

Take housing.

I started warning about the overheating market in 2004. Then a year later, I shouted from the rooftops that we were topping out — publishing the headline “Final Stage of the Real Estate Bubble” with Martin in the June 2005 Safe Money Report. The crash that followed over the next four years was the worst the American housing market has ever seen.

Then real estate investment trusts (REITs) entered their own version of la-la-land during the mid-to-late-2000s. The stocks were trading at ridiculous levels as hot money chased the sector ever higher. So I first warned here in Money and Markets in September 2006 that we were seeing a commercial real estate “binge,” with “the fundamentals going soft … valuations at pie-in-the-sky levels … and a veritable feeding frenzy going on in the sector.”

Then in May 2007, I said enough was enough. I listed five major reasons why the REIT bubble was going to burst. I recommended dumping REIT stocks across the board, or even consider going “short” through vehicles like inverse ETFs. Over the next 22 months, the benchmark iShares Dow Jones U.S. Real Estate Index Fund (NYSEARCA:IYR) plunged 76 percent!

Now we are about to roll into 2013. And the out-of-control activity I’m seeing in the market for high-risk, junk bonds is as bad — and by some measures, WORSE — than we saw in both of those instances. So it’s time to call a spade a spade. This is a dangerous, new bubble, and I recommend you get out of the way. Now!

Tsunami of cash flowing into junky bonds
Smells of yet another bubble!

The buying frenzy we're seeing in the junk bond market is fueling the next bubble.
The buying frenzy we’re seeing in the junk bond market is fueling the next bubble.

Back in the mid-2000s, we saw a speculative bacchanalia in high-risk debt. Collateralized Debt Obligations (CDOs). Collateralized Loan Obligations (CLOs). So-called PIK bonds. High-yield (junk) bonds. Investors were chasing anything and everything, even as they also loaded up on Miami condominiums and Las Vegas townhomes.

To zero in on just the junk bond part of that bubble, though, companies were able to sell an average of $144 billion in high-yield debt per year. The reason? Investor demand for anything that yielded more than Treasuries was practically insatiable, courtesy of too-low interest rates from the Federal Reserve.

But what’s going on now makes that ten-kegger frat-house blowout look like a preschool tea party!

In the first 11 months of this year, companies sold a whopping $324 billion in junk bonds, according to Dealogic. That means with one month to go in 2012, the speculative junk bond bubble is more than DOUBLE the size of anything we saw right before the 2007-2008 crash!

Separate figures from Thomson Reuters show junk bond issuance is up a whopping 36 percent year-over-year through October. More junk bonds were sold in September of this year ($43.3 billion) than in ALL of 2008!

Michael Gitlin, a fixed income official at T. Rowe Price warned in an AP story a few days ago that “It’s getting harder and harder to find places to invest,” and that “when you start seeing things like you saw in ’06 and ’07, you should be concerned.”

Meanwhile, Sheila Bair, the former head of the FDIC, is also warning about a massive bubble in risky bonds. In a column in Fortune earlier this year, she wrote “As we saw in the years leading up to the subprime crisis, yield-hungry investors are taking on more and more risk. Pension managers are investing in hedge funds, and gullible investors are buying up junk bonds.”

I couldn’t agree more!

Complacency running at levels not seen since just before the credit bubble popped! Wall Street unprepared for what’s to come! Here’s what I recommend you do …

If people were actively fleeing lousy debt securities, or buying protection against a collapse brought about by a bond meltdown, then that’d be one thing. It would show that investors were prepared for, and protected against, the bursting of another bubble.

But they’re not!

The VIX index is hovering around its lowest level since 2007, signaling the kind of complacency we haven’t seen in the stock market since just before the credit bubble burst.

And the MOVE Index, which measures bond market complacency, just sank to its lowest level since it was conceived in 1988! The only other time we even came close? 2007, right before the credit bubble burst.

Can you see why I’m so concerned?

We have massive inflows of cash into a high-risk asset class, more than double what we saw in the mid-2000s.

Even professionals are setting themselves for a fall.
Even professionals are setting themselves for a fall.

We have so-called “professionals” supremely confident in the Fed’s ability to keep those assets artificially propped up with cheap money, exactly the kind of misguided confidence that preceded the worst housing and mortgage collapse ever.

And we have investors largely flying without protection … no parachute in the form of options or other hedges against the popping of this huge bubble.

So here’s my prescription for what to do:

If you own the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK), sell it.

If you own the iShares iBoxx $ High Yield Corporate Bond Fund (NYSEARCA:HYG), sell it.

If you own the PowerShares Fundamental High Yield Corporate Bond ETF (NYSEARCA:PHB), sell it.

And if you own junk bond mutual funds, or individual junk bonds, that you can’t sell for tax or other reasons, consider hedging with the ProShares Short High Yield (NYSEARCA:SJB).

Until next time,

Written By Mike Larson From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaMare based upon data whose accuracy is deemed reliable but not guaranteed.  Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual   prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

This investment news is brought to you by Money and MarketsMoney and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss  Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of  investing, interest rates, financial safety and economic forecasting.  To view archives or subscribe, visit http://www.moneyandmarkets.com/.

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