Here's the good news for buyers of newly sold corporate bonds: They have a chance to profit from a quick pop in price that's typical in the days after the sale.
Here's the bad news: If they don't take advantage of that opportunity, they may be stuck with notes that trade rarely or never again. In a worst-case scenario, investors could find themselves stuck with bonds they don't truly want after buying them in a booming market only to watch them lose value quickly when sentiment sours.
This is relevant right now because of a continuing corporate-debt boom. This year's $501.4 billion of U.S. investment-grade bond sales are on track for the second-fastest pace of issuance on record, data compiled by Bloomberg show. And this comes after years and years of blockbuster sales that have roughly doubled the size of both the high-grade and junk markets in the U.S. since the end of 2008.
Deutsche Bank credit analysts Oleg Melentyev and Daniel Sorid highlighted just how immobile corporate bonds become within the first few days after being first sold. Between days one and five, average volume drops by 80 percent for high-yield bonds and 65 percent for investment-grade notes, they wrote in a May 6 report. Within the next 20 days, volumes drop another 50 percent, the analysts wrote.
"Generally, bonds turn from liquidity magnets to liquidity drains when they turn between 2-3 years old," according to the researchers.
This is fine for investors planning to hold bonds until they come due, but it's a big problem for buyers who hope to have some flexibility to rearrange their holdings.
The danger seems less imminent when corporate balance sheets still look pretty good and as yields plunge to new lows in light of ultra-easy monetary policies around the world. But there are signs that's changing, with the speculative-grade default rate poised to reach 3.9 percent in April, up from 2.1 percent in the month a year earlier, Fitch Ratings data show.
There's another problem with a rapid slowdown in trading after its first sold: It's tough for indexed-bond funds to truly evaluate their holdings in real time because a lot of the underlying debt has become relatively hard to trade by the time it gets included in the benchmarks at monthly rebalancings.
The fickle nature of a bond's activity increases the chance that big bond investors will experience a more rapid plunge in prices than perhaps they've accounted for on any bit of bad news. After all, if credit investors go to sell their holdings in a pinch, they may find they've been valuing them incorrectly for years.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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