This area of the market has 'rallied relentlessly,’ and Tom Lee says it's getting him 'very nervous'

Signs of irrational exuberance appear to be emerging in the junk bond market, and they could end up being a bad omen for stocks.

Fundstrat Global Advisors' Tom Lee finds the rally in the European high-yield market troubling.

"That market has rallied relentlessly this year," the firm's head of research and managing partner said Monday on CNBC's "Trading Nation." "Unlike U.S. high yield which if you pull up [iShares iBoxx $ High Yield Corporate Bond ETF] HYG's chart it's acted flat, European high yield has had a great rally this year. But, it's pushed the level of yield in Europe to 2.17 percent."

The high-yield or junk bond market boasts the lowest quality of credit and has the highest risks of default in the fixed income space. The area often exhibits equity-like behavior, and it's often seen as a key stock market indicator.

"High yield historically rallies before stock markets finally bottom," Lee added.

He did some math that suggests the problem may be bigger than many investors realize.

"A European junk bond issuer can borrow money cheaper today than the U.S. government. And, if you're double-B rated in Europe which is the higher end of junk in Europe, you're borrowing at 1.6 percent," he said. "So, you're borrowing 50 basis points cheaper than the U.S. government if you're a junk bond issuer in Europe."

Plus, Lee points out in a recent research note another — perhaps more disturbing — issue that's creating a "moral hazard."

"The second problem is that European high-yield bonds are now implying a negative default rate. They are implying that nobody who's a junk bond issuer in Europe will ever actually default on a bond," he said.

Lee is blaming European monetary policy for the pricing distortion among European junk bonds. He's worried the risk will spill into the U.S. high-yield market — noting that this area rallied here just before the financial crisis erupted in 2008.

"That would be, I think, the thing that's getting me very nervous," Lee said.

Vote
Vote to see results
Total Votes:

Not a Scientific Survey. Results may not total 100% due to rounding.

Videos

Trades to Watch

Trader Bios

About

Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Sara Eisen

Sara Eisen joined CNBC in December 2013 as a correspondent, focusing on the global consumer. She is co-anchor of the 10AM ET hour of CNBC's "Squawk on the Street" (M-F, 9AM-11AM ET), broadcast from Post 9 at the New York Stock Exchange.

In March 2018, Eisen was named co-anchor of CNBC's "Power Lunch" (M-F, 1PM-3PM ET), which broadcasts from CNBC Global Headquarters in Englewood Cliffs, N.J.

Read more

Connect