Another “Cockroach” Appears in the Markets (Justin Spittler)

Originally Published by Casey Research

Another giant junk bond fund is shutting down…

If you’ve been reading the Daily Dispatch lately, you know we’re closely watching the price action in junk bonds. The junk bond market is where companies with shaky finances go to borrow money. These companies are often the first to miss a debt payment when the economy slows. So problems in the junk bond market can serve as an “early warning” of bigger problems in the stock market and economy.

The junk bond market has flashed a lot of troubling signs recently…

iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the largest junk bond ETF, has crashed 11% this year, setting junk bonds up for their first losing year since the financial crisis in 2008. Yesterday, we told you that a $789 million junk bond mutual fund is closing down…and may not give investors their money back for months. According to Reuters, it’s the largest mutual fund failure since 2008.

• Yesterday, an even larger junk bond fund decided to shut down…

Lucidus Capital Partners decided to close its $900 million junk bond fund after a “significant investor” tried to withdraw money from the fund in October. Lucidus will sell all of its bonds and return investors’ money next month.

• Respected gurus are warning that this could turn into a full-blown crisis …

Jeff Gundlach, a star money manager and one of the world’s leading bond experts, said, “there’s never just one cockroach,” when the first junk bond fund failed last week. He was right…a total of three junk bond funds have failed in just the last week. We expect more failures in the coming weeks.

Wall Street legend Carl Icahn, who is one of the 30 richest people on the planet, is also warning about junk bonds...

Over the summer, Icahn called what’s happening in the junk bond market an “extremely dangerous situation.” And on Friday, Icahn wrote, “unfortunately I believe the meltdown in High Yield is just beginning.” Later that day, he told CNBC, “The high-yield [junk bond] market is just a keg of dynamite that sooner or later will blow up.”

• A crisis in junk bonds could spread across the financial system…

In 2007, the U.S. housing market collapsed. At the time, many thought the housing collapse would not spread to the broad economy and stock market. In 2007, former Fed Chairman Ben Bernanke said:

... the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.

As you surely know, Bernanke was dead wrong. The housing collapse sparked a financial crisis that almost took down the global financial system. The S&P 500 plunged 57%.

Right now, there’s a similar risk that problems in the junk bond market could spread to the stock market and the rest of the economy. The U.S. stock market is already showing cracks…

Last week, the S&P 500 fell 3.8%, for its worst week in nearly four months. And after a 199% gain from 2009 to 2014, the bull market in U.S. stocks has petered out. U.S. stocks are down 1% in 2015.

• Switching gears, the Fed may raise its key interest rate tomorrow...

Casey readers know the Federal Reserve has held interest rates at effectively zero since 2008. By making it incredibly cheap to borrow money, the Fed fueled a massive borrowing binge…

According to the Securities Industry and Financial Markets Association (SIFMA), U.S. companies borrowed an all-time record $1.44 trillion last year. Margin debt, which is money borrowed to buy stocks, also hit an all-time high this spring.

The flood of easy money has helped fuel a historic rally in U.S. stocks…

We mentioned earlier that the S&P 500 has gained 199% since 2009. That’s far higher than the average gain of 136% for U.S. bull markets going back to 1932. And the current bull market that began in March 2009 is now 31 months older than the average bull market since World War II. Plus, U.S. stocks are currently 52% more expensive than their historic average, according to the popular CAPE valuation ratio.

Tomorrow, the Fed is widely expected to raise rates for the first time in nine years. Most analysts expect the Fed to raise its key rate to between 0.25% and 0.50%, which would still be far below the historic average of 5%.

Many investors are nervous that a rate hike is the end of the “easy money” party of the last seven years. On Monday, The Wall Street Journal reported:

What goes down must come up, and so after seven long years the Federal Reserve is finally poised this week to get off its near-zero interest-rate bound. Along with this come the financial tensions of unwinding the Fed’s long gamble with unconventional monetary stimulus.

• To us, there’s no use guessing whether or not the Fed will raise rates…

The important thing to understand is we’re in uncharted territory. The Fed has never before dropped interest rates to zero and left them there for seven years. The world has never seen cheap money and borrowing on the scale we’re seeing today.

Most people see the Fed as a group of genius economists who know how to steer the economy to prosperity. This is dead wrong. And it’s an extremely dangerous assumption.

No one, including the people who run the Fed, knows how this is going to work out. It’s impossible to know…because we’ve never been in this situation before. We’re living through the biggest, most reckless monetary experiment in the history of mankind. And it’s likely to end in disaster.

Our advice: Put some of your wealth outside the “blast radius” of a financial crisis. We recorded a free video with all of our best advice on how to do this. Click here to watch.

Chart of the Day

Junk bond investors panicked on Friday…

Earlier, we told you that junk bonds have crashed in the last few weeks. On Friday, junk bonds had their worst trading day since 2011. Today’s chart shows just how bad things got …

The line below shows the volume of all shares of HYG (the largest junk bond ETF) bought and sold each day. As you can see, HYG’s trading volume skyrocketed during Friday’s selloff. Investors traded nearly $4.3 billion worth of HYG…three times more than any other corporate bond ETF in history.

Frantic selling is a sign of an unhealthy market. We think more losses are coming for junk bonds.

The article Another “Cockroach” Appears in the Markets was originally published at caseyresearch.com.

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Another “Cockroach” Appears in the Markets (Justin Spittler)