One effect of quantitative easing across the globe has been to make investors rather careless about who or what they invest in.
With money easy to come by, the notion that a company might go bankrupt, and that this is something you should consider before lending to or investing in it, has become rather quaint.
After all, even if you decide you’d rather stop lending to a given company, there is always some mug around the corner to take the debt off your hands.
But it’s starting to look like the supply of mugs is drying up…
Stability leads to fragility
This year has seen more corporate defaults than any in the last ten years, apart from the crisis-aftermath year of 2009, reports the FT. The number is just under 100 this year, compared to 222 in 2009, according to credit ratings agency S&P.
Nearly two thirds of those are in the US. And you can probably guess which sector is suffering the most: energy and natural resources.
The collapse in the oil price – driven by Saudi Arabia’s desire to bankrupt the US shale oil producers, whatever the cost to its own exchequer – has taken a heavy toll on the sector.
Investors who remained willing to pump money into struggling shale producers this time last year, believing a bounceback was only a matter of time, are less confident now that the oil price has been hammered so hard, for so long.
The rise in defaults has driven up the yield on corporate junk bonds in the US, from 5.6% at the start of 2014, to 8% now, according to the FT. Again, most of the real stress is in the resources-related sectors, which yield an average of 12% now.
Now, clearly we’ve been in an unprecedented environment for bankruptcies – in that there have been very few of them. And by the standards of the ‘olden days’, the current and forecast number of future defaults remains “muted”, as Dian Vazza of S&P puts it to the FT.
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The tricky thing about stability though – as Hyman Minsky taught us – is that it breeds instability. Markets have a tendency to push things until they break. So even in the most benign environment, all that happens is that they get careless.
No one defaulted last year, goes the thinking. So why would they default this year? And if no one defaulted last year, well, who needs all these protections? And who needs a high yield? It’s all going to be fine anyway.
Of course, when everyone thinks like that, all you’re doing is piling risk on top of risk. The structure of the market becomes ever more vulnerable, and eventually you reach a point where you don’t need a massive shock to send the whole thing toppling over – pretty much anything will do.
As a result, says Vazza, “the current crop of US speculative-grade issuers appears fragile and particularly susceptible to any sudden or unanticipated shocks”.
The most destructive side-effect of constant central bank intervention
This is one of the most destructive side-effects of central banks’ efforts to sidestep recessions, depressions and all the rest of that horrible but occasionally necessary stuff.
If you don’t allow the market to have a clear-out sometimes, and you don’t allow it to discipline bad habits (bad habits such as lending to companies that are in serious danger of going bust), then you aid and abet the creation of this ever-more precarious structure.
It’s ‘moral hazard’ again – it’s not a terribly fashionable view, but it’s the one that makes most sense to me in light of human behaviour.
So how are markets that are conditioned to the Fed and co always stepping in to save the day going to react to higher interest rates, should they be forthcoming? I’m not sure they’ll be as relaxed as everyone hopes.
Already we’ve seen plenty more wobbles in the market as the dollar has re-embarked on its bull run, following the Fed’s commitment to raising rates in December.
And weird things are happening across the entire bond market – we’ll have more on this in the next issue of MoneyWeek magazine – but it largely boils down to the lack of liquidity in the markets.
Meanwhile, we have a slow but steady escalation in the chaos in Syria and the threat on our own doorstep. This morning I’ve seen that Turkey says that it has shot down a Russian warplane that entered its airspace. (No wonder the defence stocks mentioned in our MoneyWeek cover story at the end of October have seen near double-digit gains already).
In short, if you’re looking for avalanche triggers – there are plenty of them about.