We are approaching the most anticipated and crucial week of the past seven years, and the global markets have been selling off. Last week, saw crude oil, junk bonds and the stock market competing with one another, while on their way down. Is there a connection between the three, or is it just a co-incidence that all three have fallen concurrently? Is the fall of one market, signaling a warning sign to the other(s)?

 If you have any interest in either market, by way of investments, or if you are planning to become a part of the market, this article is for you. The junk bond markets are flashing a red signal, therefore, you should heed the warning.

What are junk bonds and why are they important?

The bonds issued by companies, which have a low credit rating, are termed as “junk bonds”. Due to their weak balance sheet and their dubious track record, these companies are considered risky. So why would anyone invest in this instrument? With the Fed keeping interest rates near a zero level, for the past seven years, the hunger for higher returns have led many to invest in the “junk bonds” (which offer very high returns compared to the treasury bills).

What is the size of the bond market?

The total bonds issued, since the last financial crisis, have now crossed $9.3 trillion. Yes, you read correctly; it is a trillion with a ‘T’. The bonds issued in 2014, reached a record level at $1.3 trillion and the year 2015 has created another new record. According to the Financial Times, 50% of the bonds issued by the corporate world, are rated as “junk”, (this figure was at 40% during the 2007 financial crisis).
What is corporate America doing with such massive debts?
Has all this massive debt incurred by companies, been used for infrastructure, R & D, upgrade technology or for improved businesses? No! Most of the debt has rolled back into the stock market, in the form of buybacks and dividends. According to Bloomberg news, 104% of the profits earned by the companies in the S&P 500 were used for buybacks or dividends during the first quarter of 2015. Surprised? Don’t be. They went on to say that the last time the figure crossed 100%, was in the second quarter of 2007 and it peaked at 156%, two quarters later. We all know what happened to the stock markets after 2008.