U.S. stocks opened higher this morning, with the S&P 500 (^GSPC 1.06%) and the narrower, price-weighted Dow Jones Industrial Average (^DJI 0.62%) down % and %, respectively, at a.m. EDT.
3 Signs irrational exuberance is back
Irrational exuberance is back, and the process by which it returned is well-documented. As legendary hedge-fund manager Leon Cooperman of Omega Advisors told Barron's this month (sign-up may be required to view article):
Everyone is in the process of moving up the risk curve. We have an investor who put all of his money in T-bills when he retired, because he didn't want duration risk or credit risk. So for the guy who bought T-bills, he can't get any return anymore, so he migrated to T-bonds. The guy who bought T-bonds has migrated into industrial credits. The buyers of industrial credits have migrated into high yield. The high-yield buyers have migrated into structured credit, where we are now in our credit exposure at Omega, and the structured-credit people are increasingly looking at equities.
And the equities people, you ask? They're funding biotech start-ups (see the third sign below).
I'll take mine covenant-lite, please
The Financial Times is reporting today that fixed-income investors, desperate for yield, are forgoing traditional protections on loans to high-risk companies. Indeed, "the proportion of so-called 'cov-lite' loans has soared to more than 50 per cent of all leveraged loan issuance so far this year, twice the level seen during the credit boom in 2007." "Cov-lite loans" are loans issued without covenants that may require borrowers to maintain a certain level of profitability or constrain their ability to take on additional debt. As one strategist commented, "This is a new market, and this is a new norm." All this talk of "new" reminds me of another concept that ended tragically for investors: the "new economy."
5%: The new high yield
When the yield on high-yield bond indexes fell below 7% last year, that was enough to raise my eyebrows, but I could not then imagine that they would go on to break 5%, a milestone they achieved earlier this month. I suspect this has to do with the popularity of the iShares iBoxx $ High Yield Corporate Bond Fund (HYG 0.30%) and the SPDR Barclays High Yield Bond ETF (JNK 0.34%). Shareholders in these funds ought to beware: The junk-bond market looks a bit like a house of cards. Poor-quality issuers have been able to refinance their debt at record low rates, but that is dependent on the Fed's zero-interest-rate policy and quantitative easing. In other words, it must end at some point -- and at what cost to investors?
Biotech funding is booming
According to another article in today's Financial Times, 10 biotech start-ups have raised $725 million this year, and both numbers could double in the next several months. In explaining the warm reception these high-risk companies received, one investment banker told the newspaper: "What's helping push the current market is that more generalist investors are taking a look at this asset class."
The 60% return that Vertex Pharmaceuticals (VRTX 1.55%) achieved in a single day last month on the test results of a cystic-fibrosis drug is the sort of thing that gets investors' salivary glands flowing. (This is not an illiquid micro-cap stock, by the way; with a market capitalization that exceeds $17 billion, Vertex is a large-cap issue.)
Even if you don't invest in leveraged loans, high-yield bonds, or biotech start-ups, you ought to be aware of these signs of exuberance, which can be found in virtually all corners of different asset markets: The U.S. stock market cannot continue to rise at the blistering pace it has maintained since the beginning of the year.
