Are China’s Junk Bonds Turning To Trash?

Are China’s Junk Bonds Turning To Trash?
Theodora Lee Joseph, CFA

over 1 year ago2 mins

The Chinese government’s recent clampdown on the real estate sector has brought construction all over the country to a standstill. Chinese consumers have responded by leading a boycott on the mortgages of their unfinished properties, placing fresh pressure on the nation’s junk dollar bonds. Junk bonds – sometimes more politely termed high-yield bonds – are a type of debt issued by companies that have a high risk of defaulting. They might be riskier than other investment grade bonds, but investors love them because they provide high interest rates to compensate for that risk of default.

But it doesn’t seem like investors’ recent bets in China’s offshore junk bond markets have gone well. As you can see above, the proportion of junk bonds trading below 20 cents – 80% below their value – has close to quadrupled since the start of this year. Here’s why that’s a problem: lower prices for a dollar worth of debt mean the market is pricing in a higher risk of default – and that’s bad news for investors who previously thought their bonds would be worth more. And since the bulk of China’s issued junk bonds are tied to property firms, this drop off in price could signal that the market isn’t confident that those companies can raise enough cash to fulfil their obligations.

If you’re keen to invest in Chinese stocks, keeping an eye on the Chinese offshore junk bond market is just the thing to do. After all, knowing what’s happening in the junk bond market can help you gauge how risk averse investors are at a point in time. On top of that, its performance can serve as a good leading indicator for stocks performance: when investors feel more confident that companies are financially sound, the credit market will likely start recovering first, then stocks should follow suit.

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