Much is made of the 'apparent' bubble in Treasury bonds - a 30-year or so relatively consistent trend in government bonds (through thick and thin) and yet allocations remain minimal compared to our increasingly similar Japanese friends have experienced. It would seem to us, thanks to Bernanke's 'visible' hand that the real bubble is in spread product - as rates are so compressed, investors seemingly oblivious to the word 'risk' (unintended consequence) have flooded into ever-increasing yield/spread products - with high-yield bonds now dominated by these technical inflows (as we noted in the close today). If ever the combination of anchoring bias, 'dance while the music is playing', and herding was evident, it is in corporate credit. To wit, the total disengagement from reality (both real 'micro' earnings and 'macro' economic uncertainty) that a flood of money has created in this increasingly crowded (and increasingly-er illiquid) market. Managers are well aware that the liquidity tsunami has moved the maturity mountain (as Citi's Matt King notes) but has helped the weeds as well as the roses.
The front-running risk-averse yield-seeking flood of money into corporate bonds has technically crushed spreads...
But it has reached epic proportions of disconnection in recent quarters as 'micro' earnings have missed expectations (inverted on scale below - presented as distance from pre-season expectations we have had 5 quarters in a row of misses) but spreads continue to compress...
and given the massive (almost unprecedented) levels of 'macro' policy uncertainty, the flow of safe-haven-but-yield-chasing cash has broken the link between the reality of risk and the pricing of risk...
and has therefore removed signaling-effects from this critical market. More importantly, the wall of liquidity that has been squeezed into a relatively small market has lifted all boats and enabled the entire maturity structure of corporate debt to be kicked down the road - unfortunately enabling the dead to live 'unproductively' far longer than they ever should - necessarily dragging mal-investment in at every turn...
So this leaves corporate bond managers 'dancing while the music plays' yet fully aware that the market simply cannot bear the type of exit that will occur should reality ever seep back into the market's pricing (say by a fiscal shock?). As Dory would say "Just keep swimming..." as Bernanke has interfered with nature...
Charts: Citi