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Why Junk Bond Default Rates Will Go Higher In 2016

Summary

The junk bond default rate edged higher in June.

Junk bond defaults will go higher throughout the rest of the year.

Commodity prices won't recover, and investor uncertainty will make it difficult for indebted borrowers to raise capital.

In the latest sign that stock valuations are out of touch with economic reality, Moody's reported that the global default rate for junk bonds (NYSEARCA:HYG) climbed to 4.7% in July (up from 4.6% in June, and 50 basis points above the long-term average). US stocks (NYSEARCA:SPY) are at record highs, but junk bond default rates for US companies are even higher than global levels: in July that default rate climbed from 5.2% to 5.5%, and analysts speculate that it will reach 6.3% before the end of the year, led by a 10% default rate in metals and mining, and a 7.2% default rate in oil & gas.

Weakness in the commodity sectors is responsible for the historically high default rates, and there is little indication that things will get better anytime soon. According to Fitch Ratings, the TTM default rate for junk bonds hit a six-year high in June, and the value of defaults reached $50.2 billion in the first six months of the year (compared to $48.3 billion for all of 2015). Energy companies defaulted on $28.8 billion (60%) of this debt, which equates to a sector-wide...


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