Beware Goldmen Proffering Investing Ideas


Beware Goldmen Proffering Investing Ideas

Posted by Karl Denninger

So spaketh Goldman

Goldman Sachs Group Inc. is recommending high-yield, high- risk bonds with rankings in the BB tier, the first below investment grade on the Standard & Poor’s scale. Pioneer Investment Management Inc. favors BB and B bonds, the next lowest bracket, while saying the riskiest debt is overvalued. Debt ranked in the BB category gained 39.1 percent in the past 12 months, underperforming the CCC tier by 66 percentage points, according to Bank of America Merrill Lynch index data.

This sort of “advice” reminds me of Alan Greenspan telling people to go get adjustable rate mortgages when rates were at generational lows.

Bond values, assuming you don’t intend to hold to maturity, move inversely to rates.  The more duration you take on, the more they move.

So if you hold a long-duration “junk” bond with a very nice coupon and rates go higher, I hope you like holding that trash until it matures, because if you try to sell it you’re going to get an ugly surprise.

The real screw job in all of this is that it’s entirely possible you could buy a Treasury in the next few years for close to what BBs provide in terms of coupon now!

Spreads on BB ranked debt have fallen 0.66 percentage point to 4.07 percentage points since the start of the year, the Bank of America Merrill Lynch index shows.

4.07% spreads eh?  So assuming we have a 10 year instrument the current yield would be about 8%, which sounds awfully good – until the 10 year goes to 6% in a year or two.

Then it looks like hell, and as borrowing costs go up default rates will too, which means that “BB” rated debt might have realized credit risk embedded in there (but heh, you were “paid” for it, right?)

I want to own bonds in a falling rate environment.  Not only do I get an outsized coupon for the duration should I choose to hold to maturity I in addition get capital gains if I decide to sell early.  Finally, credit risk is diminished as rollover and/or issue is easier (cheaper in terms of interest cost) into a falling rate environment.

I most certainly do not wish to hold bonds in a rising rate environment.  Not only do I get a diminished coupon relative to new issues of th same credit quality if I decide to hold to maturity but if I have to sell early I’m going to get positively hammered on the net-present-value of those instruments.  Worse, whatever alleged credit risk that is embedded in those instruments has an increasing probability of turning into realized credit risk resulting in not only a mark-to-market loss due to the rising rates but an actual capital loss due to default.

Of course there’s no mention of these facts in the so-called “free press.”

I wonder why?

I also wonder if someone proffering these “ideas” has a lot of “BB” rated bonds they need to sell, or a bunch of companies that would like to issue at that credit quality they underwrite for……