Corporate Debt Conundrum

I'm seeing what we’re calling a Corporate Debt Conundrum forming. It may cause those who turn to the internet, television and the radio for their investment ideas to have to work for the rest of their lives simply to get by. For free thinkers willing to plan ahead, it may result in even their grandchildren never having to work.

When something in your life has been a reliable constant in your life for the last 40 years, including your entire investing career, you believe that constant will continue on forever. Most investors are assuming bonds will remain the source of safe, predictable cash flows, because for much of the last four decades corporate bonds were a safe investment.

Everybody with coaching in their 401K, everybody who has an investment account, everybody who reads experts on the internet believes:

1. Relying on the S&P index funds for growth is the best strategy. Warren Buffet says so. Your company 401K meeting says so, and all the money magazines say so. Why not believe them?

2. Safety comes from bonds. Instead of risking investment in companies, you lend them your money, you get interest, and get paid back your principle when the bond matures. So for 40 years this has meant a safe harbor.

3. Since 1980, a terrific and safe strategy was to own high quality corporate bonds and municipal bonds. We are all taught that the older you get, the more bonds you should own.

So now, we have a giant generation of Americans counting on investment grade corporate bonds and some equity investments in Index Funds to keep them alive for 20, 30, or 40 years in retirement. You, my listener, are probably a member of this large, growing group.

The looming problem is pension funds, endowment funds, insurance companies, quality bond funds and quality money managers are required to hold investment grade bonds. No “junk bonds.”

To understand this, you have to know what junk means in bonds. It means below investment grade.

We all rely on rating agencies, Standard and Poor’s, Moody's Investors Service and Fitch Ratings to rate the quality of these bonds. Twenty years ago, we could rely on “AAA” bonds, the highest grade.

Most of them have been downgraded over the years to “A” or “BBB.” Most portfolio managers now rely on “BBB” bonds to fill their funds. They are still investment grade, so what’s the problem?

During the last ten years, with interest rates kept near zero, many companies borrowed money to buy back stock and pay dividends. The amount of money they owe today is huge compared to what they owed twenty or even ten years ago. Huge.

They have been downgraded to “BBB,” but they are still investment grade.

Now what happens with all that debt when the economy slows down a little? Companies borrowed so much money, that even before they have trouble making their payments, they may be downgraded by the rating agencies.

Big deal, right?

Well, all those money managers – all those pension funds – all those bond funds required to only use investment grade bonds, will have to sell all the bonds that are downgraded to junk status.

Almost half of the bonds in our $5 Trillion bond market are already down to one step above junk – or non-investment grade. So when they are downgraded by one more level, below BBB, they must be sold. The problem is, all these pension funds and money managers will have to sell all those downgraded bonds at around the same time.

Remember when something like that happened in the mortgage bond market back in 2008?

Everyone wants to sell them, but there isn’t anybody to sell them to because nobody is buying!

You think you can sell that fund with the push of a button. You think it because it has been true throughout your investment life.

But what happens when everybody is selling them? The bonds have to be sold, and the buyers aren’t there to buy them.

That’s what a crash means. When the market maker doesn’t have the money and isn’t willing to buy them back, we call that a crash.

The bottom falls out.

As a seller, you push the button and your fund can’t get a reasonable price for the bonds to redeem you and send you your money. So you either get back a fraction of your money, or the bond manager actually becomes insolvent. He goes broke or crashes.

You saw it happen to the banks in 2008. The mortgage bonds crashed. The government bailed out some of the biggest banks, but the people lost their money. People didn’t get bailed out, only the biggest banks.

Here we have a whole generation of retirees counting on those bonds, as the value disappears.

This is what the next financial crisis is going to look like.

What do you do about it?

Replace those bonds while you have the chance.

The story I’m telling you is not happening now. It may be the NEXT crisis.

I can tell you what I’m doing about it.

I’m investing in the most solid assets, which generate steady, reliable income.

Simple as that.

Residential Real estate for middle class people who have to live somewhere.

Oil and gas pipelines which are contracted to move oil and gas to the refineries, and to the buyers around the world. This is about as safe as you are going to get.

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