Aug. 24, 2019, 11:01 a.m. EDT

The investing opportunity of a lifetime awaits us when the recession arrives

You’ll soon be able to buy corporate bonds at a deep discount

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By John Mauldin


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John Mauldin: “The next selloff in high-yield bonds is going to offer one of the great opportunities of my lifetime.”

The world is awash in debt.

While some countries are more indebted than others , few are in good shape. The entire world is roughly 225% leveraged to its economic output. Emerging markets are a bit less and advanced economies a little more.

But, regardless, everyone’s “real” debt is likely much bigger, since the official totals miss a lot of unfunded liabilities and other obligations.

Debt is an asset owned by the lender. It has a price, which — like anything else — can go up or down. The main variable is the lender’s confidence in repayment, which is always uncertain. But there are degrees of uncertainty. That’s why (perceived) riskier debt has higher interest rates than (perceived) safer debt. The way to win is to have better insight into the borrower’s ability to repay those loans.

If a lender owns debt in which his confidence is low, but you believe has value, you can probably buy it cheaply. If you’re right, you’ll make a profit — possibly a big one. That is exactly what happens in a recession.

Zombie companies

While it’s easy to point fingers at profligate consumers, households largely spent the last decade reducing their debt. The bigger expansion has been in government and business. Let’s zoom in on corporate debt. The U.S. investment-grade bond universe is considerably more leveraged than it was ahead of the last recession:


Gluskin Sheff

Compared to earnings, U.S. bond issuers are about 50% more leveraged now than in 2007. In other words, they’ve grown debt faster than profits.

Many borrowed cash not to grow the business, but to buy back shares. It’s been, as my friend David Rosenberg calls it, a giant debt-for-equity swap.

There’s another factor, though. Today’s “investment-grade” universe contains a higher proportion of riskier companies. The lowest investment grade tier, BBB, now constitutes half of all issuers:


Gluskin Sheff

All these are just one downgrade away from being high-yield “junk bonds.” The best data I can find shows that there are roughly $3 trillion worth of BBB bonds and another roughly $1 trillion worth of lower-rated bonds that would still be called “high-yield.” If it happens like last time, the ratings agencies will wait until their fate is already sealed before they cut ratings on these zombies. But that’s only part of the problem.

Selling under pressure

I expect liquidity in these below-investment-grade bonds to disappear quickly in the next financial crisis . We got a small hint of how this will look in the December 2015 meltdown of Third Avenue Focused Credit Fund, which had to suspend redemptions and then spend two years liquidating its assets.

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