Gary Shilling Slams Fed’s ‘Zeal for Yield’

“Consider the rush into junk bonds, depressing their yields and spreads versus Treasuries. So much money has poured into below-investment-grade debt that it now takes real skill to default. In the third quarter, junk-rated companies sold $94 billion in debt compared with $25 billion in the third quarter of 2011. Nonetheless, the global recession will hype defaults even though many low-rated companies have a cushion of safety from prefunded debt.”

“Zeal for yield” has pushed the returns on junk municipal bonds to just 3.15 percentage points more than investment-grade issues, the narrowest gap in two years, he adds.

He also notes that master limited partnerships are usually backed by energy pipelines and other investments that produce steady revenue from long-term contracts. They pay out 90% of their earnings, and are able to promote current returns of about 10% annually to investors. But in reaction to the zeal for yield, private-equity firms, with the assistance of Wall Street banks, are unloading fracking sand, gas stations and coal mines into these limited partnerships and attracting investors with “mouthwatering yields.”

“Slightly less risky are commercial mortgage-backed securities,” he concludes, “which are in such demand that their yields are at narrower spread compared with their benchmark than when real estate was still booming and risks were ignored. Such securities backed 75% of all commercial real-estate lending at the earlier peak, and are gaining in prominence again. Credit-rating companies, however, are warning that the loan quality of such mortgage-backed paper is weakening, possibly putting investors at risk.”