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Wall Street, Junk Bonds, and Markets Cycles: A Cautionary Tale

By Aspero

  • June 27, 2023
  • 2 min read

Do you recall this monologue?

“The point is, ladies and gentlemen, that greed – for lack of a better word – is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit.”

While some of you may remember this famous speech from the film “Wall Street,” where Gordon Gekko proclaimed why greed is good, the film’s producer later stated that Gekko’s character was inspired by the real-life, high-yield bond(HYB) legend Michael Milken.

Michael Douglas Greed GIF by 20th Century Fox Home Entertainment - Find & Share on GIPHY

Milken played a significant role in developing the High Yield Bond market in the 70s & 80s. Despite facing legal troubles later, Milken’s aggressive tactics financed numerous companies, including industry giants like Boeing, MGM, and Viacom. The debate regarding whether his actions ultimately benefitted American businesses or caused harm continues today.

Why is this history relevant now, nearly 50 years later? The answer lies in the current state of the junk bond market. Today, the US junk loan market is a staggering $1.4 trillion, and recent events have signalled trouble. Between January and June 2023, over $25 billion in debt defaults. Additionally, the default rate on junk bonds has risen to 6%, only seen during significant crises like the Covid pandemic and the Global Financial Crisis.

As an investor in Indian equity markets, you might wonder why this matters to you. Here are three reasons:

The recent surge in Indian equity markets: While the Nifty has seen a 10% rise in a short period, many listed companies have experienced extraordinary gains. Over 30% of companies with a market capitalization above Rs 5 billion have seen their stock prices rise by more than 30%, and some have even doubled in value. Such rapid increases may raise concerns about the sustainability of this trend.

Coordinated interest rate hikes: Central banks implementing synchronized interest rate hikes can bring unforeseen risks to the surface. Hidden excesses built up during low-interest rate periods often unravel when rates start to rise. Even a minor 25 basis-point hike can have a significant impact once rates reach around 5%. The last rate hike cycle before the Global Financial Crisis is a stark reminder of this phenomenon.

Market cycles persist: Historical patterns show that markets operate in cycles, regardless of our attention or disregard towards them. Examples such as the Nifty Fifty stocks and the BSE Small Cap Index in India demonstrate how seemingly invincible companies or market segments can experience sharp declines. It is essential to remain mindful of potential risks, even in a seemingly favorable environment.

While the current situation in India appears positive, it is crucial to approach it with caution. As investors, it is our responsibility to remain vigilant and evaluate potential risks that could arise.

Originally published on the Markets-focused portal of The Economic Times, this article explains it in detail. It is definitely worth a read!