Often the catalyst for a recession is something you cannot see. For example, the Great Recession of 2008 was due to Wall Street getting into the mortgage market and creating a mortgage product based on subprime lending or Alt A mortgages as Washington Mutual referred to them. Unfortunately, that period in U.S. history almost destroyed our banking system. We did lose several financial institutions and we did experience one of the worst market declines of our lifetime and many bond traders and investors couldn’t see what was happening. Michael Lewis wrote a great book about this period in history; The Big Short and a movie was produced as well. The book describes how only 3 or 4 people actually understood what was happening or could predict what was happening to all these subprime loans and the related collateral damage in the housing market and banking system. I highly recommend the book.
So fast forward to 2019. What are we not seeing that could create the next market downturn?. Several experts on Wall Street are beginning to point to the bond market.
Let me explain. First the bond market is an easy target. It is three times the size of the stock market. Second there are both public and private investors involved, and the federal reserve can influence interest rate policy without much effort. But there is something else. There are outside rating agency’s namely, Moody’s Investor Service, Standard and Poor’s Global Ratings and Fitch Ratings who have tremendous influence on bond prices and ultimately interest rates. If the rating agencies for example, downgrade several B rated bonds to C or to junk status the market impact would be immediate and very negative. What if the rating agencies are feeling pressure not to down grade company debt due to political and economic reasons? Money is cheap right now and interest rates are low but if companies begin to find it difficult to borrow because default risks have gone up and the rating agencies downgrade corporate debt from B- for example to C or junk status that could rattle the bond market and interest rates. Two companies of note in the S&P 500 have recently experienced a debt down grade. According to the Wall Street Journal, Newell Corporation recently had their debt downgraded to junk. https://www.wsj.com/articles/s-p-downgrade-pushes-newells-credit-rating-into-junk-11572736720 . In addition, Ford Motor debt was downgraded in September by Moody’s to junk status. https://www.cnbc.com/2019/09/09/moodys-downgrades-ford-credit-rating-to-junk-status.html
Again, this is something we cannot see today, but something to keep on eye on when looking at the bond market and repayment risk.
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