Back in June 2019 (exactly one year ago) – I published an article highlighting the increasing fragility in the corporate credit markets.

To give you some context: I wrote about the towering wall of ‘triple-B’ (BBB) rated corporate debt that was nearing a ‘tipping-point’. And how fragile corporate debt markets really were.

(Note that the BBB-rating is the last notch on the investment grade level – thus anything lower is considered ‘speculative’ – aka junk. These are known as ‘fallen angels’).

So – one year later – how are things since then?

Well – not only are things much worse now (thanks to both the 2019 global recession and 2020 COVID-pandemic). But there’s significantly more ‘fallen angels’ today than there were just a few months ago, as-well as a record number of firms at risk of becoming junk-rated.

Let me explain. . .

According to a recent S&P Global report – there are so far 24 new fallen angels worldwide in 2020 (the most since the 2015-16 slowdown).

But – most importantly – there’s now a record-high 111 ‘potential’ fallen angels (meaning: a wave of corporations are one-step away from getting downgraded to junk).

And to make matters worse – the ‘negative bias’ (aka the percentage of debtors with a negative outlook for all investment grade firms) recently reached 25% – the highest level since the 2008 financial crisis.

Just take a look at the chart below. . .

Thus – you can see how very fragile credit markets have become over the last few months.

But – that’s not all.

Because the momentum (aka the rate of change – RoC) is still to the downside. . .

(Remember: the rate of change is key for speculators as it mathematically measures the percentage change in a value over a certain period of time. Putting it simply – the larger the percentage – the greater the momentum. And just as contrarian investor Keith McCullough – CEO at Hedgeye – says: “absolutes don’t matter. It’s the rate of change that does”).

Putting this into perspective – take a look at the ratio of fallen-angel-firms-to-total-investment-grade-issuers over the last 15-years. . .

Not only has the ratio of fallen angels already surpassed its 10-year trailing average within just the last five-months. But we’ve seen a 90% increase in the rate of change for new fallen angels (i.e. 1% in Dec/2019 to 1.9% in Apr/2020 equals a 90% increase).

(Note that this is a sharp increase – especially in such a short period of time).

And considering that a record 26 of the 111 firms (most being financial, hotel, oil/gas, and auto firms) have a negative ‘CreditWatch rating’ (i.e. a risk of downgrade in less than 90-days) – there’s a strong chance that this ratio will climb significantly higher over the next 12-months. . .

And to make matters worse – there’s roughly $10-trillion in dollar-denominated corporate debt worldwide that’s maturing over the next 42 months. With peak maturities hitting in 2022 (just a little more than a year from now).

(And there’s $1.2 trillion of this debt maturing from junk-rated U.S. firms – aka fallen angels – that will desperately need funding).

This means many of these firms must either repay creditors the full amount owed with cash on hand. Or roll-over (aka refinance) their existing debts (meaning: they’ll need take out new debts to repay old debts).

But – since most of these firms are near-junk already – I’ll bet most won’t have the cash available to repay their creditors. Thus needing to borrow more.

And therein lies the problem: the cost for junk-rated firms to borrow is significantly higher than historic averages.

For instance – just take a look at the current difference in spreads between U.S. corporate debt rated BBB- (the bottom notch for IG) and BB+ (the highest notch for junk).

It’s more than 270 basis points (2.70%) – the highest it’s been since 2008. . .

This indicates significant risk-aversion in the bond market (aka investors are nervous) – leading to much wider bond spreads. (Indicating investors want higher yields for the additional risk).

This makes it costlier for lower-rated firms to borrow – which amplifies the risk of default. And risks creating an ‘iliquidity-pocket’ in the sector (aka cause liquidity to dry up as investors flee entirely).

(Keep in mind that many institutional investors – such as pension funds, insurance firms, some mutual funds, etc – can’t legally own anything other than investment grade debt. Meaning: money managers will quickly dump these holdings – leading to a further drop in junk bond prices; further accelerating the downside).

And all this happening at a time when global economic growth is extremely weak. . .

Thus – corporations (especially the near-junk-rated kind) are more fragile than they’ve been in the last 15 years. And going forward – speculators should expect a possible wave of defaults and downgrades.

Or – putting it another way – there’s a high chance for a black swan to show up in the corporate credit market.

So – in summary – the record number of potential fallen angels has put bond holders (including insurance firms, pensions, and investment funds) in a fragile position. Especially as both economic conditions and corporate earnings continue to under-perform.

Putting it simply – the bond market’s at great risk of choking on all these potential fallen angels.

So don’t be surprised if it eventually does.

I sure won’t.

P.S. – no wonder the Federal Reserve began buying both BBB-rated and junk-rated debt in late-May 2020 for the first time ever. There are just far too many companies at the margin of being downgraded – which would likely cripple lending markets. Thus expect the Fed to ramp up their junk-bond buying with more printed money in the future.