When we look back on this period in the financial markets, how will it be remembered?

Well, I believe that the last couple of years will largely be defined by the “reach for yield” and exuberance in the high-yield bond market.

It’s become common to dismiss the problems in high-yield land because they’re seemingly limited to the energy sector. However, the market is slowly going to realize that the high-yield debacle isn’t “contained.”

And last week, the junk bond market got a jolt.

A Nasty Shock for Yield-Chasing Valeant Investors

As you probably know, shares of Valeant Pharmaceuticals International Inc. (VRX) got hammered last week when the company became the target of fraud allegations.

As for the company’s fixed-income securities… the 6.125% bonds due in 2025 traded down to $83.50 on October 22. As recently as early August, those same bonds traded for more than $104.

The following table shows some of the largest U.S. high-yield issuers this year. Valeant actually tops the list.

It probably comes as a surprise to many Valeant equity traders and investors that the company has a sub-investment grade credit rating.

Now, Valeant may or may not default. But what’s clear is that the mispricing in the high-yield debt market allows companies like Valeant to lever up with impunity.

Equity shareholders are also complicit for having failed to punish companies with too much leverage.

Whether it’s a sharp decline in oil prices, corporate malfeasance, an economic downturn, or some other unforeseen event, the risks that may cause a default are manifold.

And these risks pose an even greater threat to investors in highly-levered companies.

Nonetheless, investors are flooding back into junk bonds.

Like Lambs to the Slaughter

So far in October, the SPDR Barclays High Yield Bond ETF (JNK) and the iShares iBoxx High Yield Corporate Bond ETF (HYG) have experienced inflows of $2.1 billion and $1.7 billion, respectively.