When High-Risk Loans Blow Up


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Ever heard of the S&P/LSTA U.S. Leveraged Loan 100 Index? Probably not. But as an investor who cares about building or preserving wealth, you should definitely pay attention to the message it’s sending out.

To briefly explain: This index tracks the performance of 100 large, higher-risk, higher-yielding loans. They have a term of at least one year, are denominated in U.S. dollars and are issued on a senior secured basis.

These kinds of loans are typically used to finance leveraged buyouts, mergers and acquisitions or other corporate actions, all of which soar at the tail end of a credit cycle. They’re usually taken out by higher-risk companies with a lot of existing debt and lower credit ratings. As a result, they’re among the first loans to sour when the economy starts breaking down, credit conditions start tightening and easy money drains out of capital markets.

With that preamble out of the way, take a look at this chart of the index …

Click image for larger view

You can see that it topped out in mid-2014 — before the recent stock market struggles. You can also see it made a “lower high” in early 2015, and has done nothing but fall since then. As a matter of fact, it just hit the lowest level in more than three years.

That’s why you’ve been losing money if you own something like the PowerShares Senior Loan Portfolio (BKLN). The $4.6 billion ETF invests in leveraged loans, and it’s down about 2% in the past year.

But what’s more important to all of us is the broader signal this index is sending out — about the economy and the stock market as a whole. Not only has it been deteriorating for more than a year, but it also didn’t bounce at all with stocks in the last several weeks.

That’s yet another in the long and growing list of ugly divergences and disconnects I’ve been highlighting. It also “fits” with the ongoing deterioration in junk bonds.

They haven’t bounced much at all — as you can see for yourself just by punching up a multi-year chart of the SPDR Barclays High Yield Bond ETF (JNK). That ETF has lost around 5.5% in the past year, a wide and growing divergence with the S&P 500 (+4.3% in that time frame).

I’ve said it before and I’ll say it again: My experience has shown time and again that credit markets give you an early, advance warning of problems in equity markets. That was especially true in the last major down cycle, the great credit crisis, bear market and recession of 2007-09.

I know plenty of fast money stock jockeys who wouldn’t know a leveraged loan from a hole in the ground. But I know that as a Money and Markets reader, you’re not that kind of investor. That’s why I will continue to highlight things going on behind the headlines — like the deterioration in leveraged loans. And it’s why I will do my best to help you protect (and build) your wealth as the consequences potentially spill over into the broader markets.

Until next time,

Mike Larson


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