An Honest Take on Difficult Circumstances

When bond yields first went negative, I called a long-time confidante. I whispered into the phone, “Someone is paying someone to borrow their money? That makes no sense.”

Over the next few days, weeks, and months, many articles would be published trying to make sense of negative interest rates. It turns out many folks were confused by this. For the record, we still find it amazing that people are paying someone to borrow their money. But, we suppose that is a rant for another day.

James Mackintosh recently wrote a refreshingly honest appraisal of debt markets in the Wall Street Journal. His piece is a brilliant attempt to reconcile “the weirdness” in Treasury markets today. We loved the honesty. Even a brilliant veteran financial journalist like Mr. Mackintosh finds today’s markets bizarre.

We agree that markets are confusing today. The chart below is our reproduction of a “side” chart halfway down Mr. Mackintosh’s article showing Junk Bond spreads coming off record lows.

We found the chart jarring. We’ve all read that real yields on junk bonds are now negative.

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Indulge us in some technical analysis. Would you rather be “long” or “short” the line below?

After Exploding to 10 High Yield Junk Bond Spreads are Bouncing off Record Lows

Risk Scorecards: Spreads in High Yield are Flashing Red

Pretend we are giving you an eye exam. Look at Figure 1 above again. Short or long? Look at the chart below. How about now?

Being “long” that line means you think the days of covenant-lite junk debt combined with the lowest spreads in history will end badly. If you think otherwise, we encourage a read of The Economist’s fantastic article, The Junk Heap: America’s high-yield debt is on ever-shakier foundations.

That is quite the chart in our view. We are talking about spreads coming off 35-year lows. And this, when underlying bond yields themselves just plummeted amidst soaring inflation numbers.

For those who want to make money when that line rises, this article is for you. For those of you long high yield credit ETFs, we encourage caution!!

High Yield Spreads are Coming Off Record Lows


Our key point is as follows:

We have published a summary of Klarman’s A Margin of Safety, which cautions investors against chasing yield and buying expensive stocks in periods of low-interest rates. We brought you the chart showing that $6 trillion worth of companies lack the operating income to pay their interest expense.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

[1] Hat tip to the Grant Williams podcast with George Noble for the term

[2] Carvana, 10K, pages 16-20


The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

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August 18, 2021 |

Categories: Quick Takes

August 18, 2021

Categories: Quick Takes

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