All the nightmares for stock investors start in bond market


If there’s one thing the prophets agree on, it’s that the end will come in the bond market. Even for stocks.
Prophesies of doom are everywhere. There’s billionaire investor Stan Druckenmiller, who says our “massive debt problem” will ignite a crisis. Oaktree Capital’s Howard Marks warns that public and private debt will be “ground zero when things next go wrong.” And Citadel’s Ken Griffin sees a credit binge ending badly.
If you’re an equity investor, all the hectoring has probably left you frazzled, staring anxiously at fixed-income markets for early signs of the apocalypse. So it’s no mystery why the sight of 10-year Treasury yields spinning higher at the fastest rate in two years was enough to send the S&P 500 to its worst two-day tumble since May.
“There are a lot of people waiting for the world to end because of this bond market,” said Brad McMillan, chief investment officer for Commonwealth Financial Network, which oversees $156 billion. “Low rates will keep going forever — a lot of justification for high valuations is based on the assumption. That assumption is largely broken.” To be sure, the biggest weekly decline in a month for the S&P 500 wasn’t that big — just 1 percent. Which is testament to how hard it’s been to worry stock traders. If this episode is different, if it rises above past threats that couldn’t lay a glove on stocks — trade wars, emerging economy implosions — it’s because it has its root in something investors have trouble brushing aside: credit.
Any number of bond market hypotheticals are capable of terrifying stock bulls. They pertain to the startling amount of credit swirling around the US economy — and the possibility it will turn sour. The government’s budget deficit has swelled, contributing to the country’s debt load, now at $21.5 trillion.
Meanwhile, corporate America has gone on a borrowing spree to take advantage of near-record low rates. Excluding financials, S&P 500 companies have more than doubled their borrowings to $5 trillion over the past decade, data compiled by Bloomberg show.
Should interest rates rise and growth slow, companies are bound to see to their financial soundness deteriorate. More than $1 trillion of investment grade corporate bonds could be cut in the next downgrade cycle, according to analysis this week by Morgan Stanley.
“Leverage is near all-time highs, and companies used tax reform proceeds for buybacks instead of paying down debt,” said Max Gokhman, head of asset allocation for Pacific Life Fund Advisors, which manages $40 billion. “More than triple the debt that came due in 2018 will be due each year from ‘19-’21. If yields go up, there’s real concern about companies’ ability to reissue and keep their leverage.”
For now, pain in stocks has been limited. The S&P 500 is 1.5 percent from a record reached September 20.
Dig a little deeper and there are signs credit concerns are being felt.

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