Credit Markets

     

 

 

Distortions and Crazy Ideas

We have come across a few articles recently that discuss some of the strategies investors are using or contemplating to use as a result of the market distortions caused by current central bank policies. Readers have no doubt noticed that numerous inter-market correlations seem to have been suspended lately, and that many things are happening that superficially seem to make little sense (e.g. falling junk bond yields while defaults are surging; the yen rising since the BoJ adopted negative rates; stocks rising amid a persistent decline in earnings growth; bonds, gold and stocks moving in unison, etc., etc.).

 

puzzled-man-scratching-headUnknown veteran trader experiences another WTF moment.

Photo credit: Everett Collection

 

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A First Step Toward Sound Money

The Arizona House of Representatives has convened an Ad Hoc Committee on Gold Bonds. The purpose is to explore if and how the state could sell a gold bond.

 

fourth-liberty-loan-50-gold-bond-of-1933-1938-8A United States gold bond of yore: the 4.25% Liberty Loan of 1933-1938

 

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Insanity Rules

Bond markets are certainly displaying a lot of enthusiasm at the moment – and it doesn’t matter which bonds one looks at, as the famous “hunt for yield” continues to obliterate interest returns across the board like a steamroller. Corporate and government debt have been soaring for years, but investor appetite for such debt has evidently grown even more.

 

Perfect-InvestmentThe perfect investment for modern times: interest-free risk!

Illuustration by Howard McWilliam

 

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Bezzle

BALTIMORE –  Barron’s, in a lather, says the market is facing the “Two Horsemen of the Apocalypse.” Huh?

 

Apocalypse_vasnetsovOnly two? There were four last time!

 

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A Sucker’s Deal

The yield on the 10-Year Treasury note’s accelerating its descent toward zero.  The last we checked the yield was at about 1.56 percent.  But in every practical sense, for income investors, a yield of 1.56 percent may as well be zero.

 

1 - 10 year treasury note yieldEven though the US treasury note is like the one-eyed man in the land of the blind these days, it still is a guarantee to lose money in real terms if held to maturity – click to enlarge.

 

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The Sharp Move in the VIX Accelerates

In Monday’s trading session, the upward move in the volatility index VIX (which measures the implied volatility of SPX options) continued unabated, vastly out of proportion with the move in the underlying stock index. “Brexit” fears continue to grow, which has apparently been the driving force behind this move.

 

Una manifestazione a favore di Brexit a LondraThe “Brexiteers” are gaining support as the referendum date draws closer – global financial markets are getting somewhat upset over this.

Photo credit: Neil Hall / Reuters

 

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Money Printing and Price Inflation

Ten years back when the central banks around the western world—as elsewhere—were printing money with abandon, it was claimed by rational observers that this would lead to hyper-inflation. It was claimed that the best the central banks could do was to control short-term interest rates, surreptitiously expropriating the wealth of citizens.

Eventually the market had to find out, directly or indirectly, what was happening — as newly printed currency played havoc in the market — and prices in nominal terms would rise. Long-term yields on sovereign bonds were expected to sky-rocket, to account for increasing inflation.

 

800px-Salon_de_Madame_GeoffrinThe Age of Reason: Salon de Madame Goeffrin, a painting by Anicet Charles Gabriel Lemonnier, showing distinguished French thinkers of the Enlightenment gathered in one room.

 

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Loan Losses and Rumors

We want to briefly comment on recent news about a rise in loan loss provisions at US banks and rumors that have lately made waves in this context.

 

iceberg, ClevengerThe iceberg – an excellent simile for what we know and what we don’t know… or rather, what we don’t know just yet.

Image credit: Ralph A. Clevenger

 

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Trouble in High Yield Bonds Begins to Spread

It has become clear now that the troubles in the oil patch and the junk bond market are beginning to spread beyond their source – just as we have always argued would eventually happen. Readers are probably aware that today was an abysmal day for “risk assets”. A variety of triggers can be discerned for this: the Chinese yuan fell to a new low for the move; the Fed’s planned rate hike is just days away; the selling in junk bonds has begun to become “disorderly”.

 

288205Photo credit: ORF

 

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While the Stock Market is Partying …

There are seemingly always “good reasons” why troubles in a sector of the credit markets are supposed to be ignored – or so people are telling us, every single time. Readers may recall how the developing problems in the sub-prime sector of the mortgage credit market were greeted by officials and countless market observers in the beginning in 2007.

 

oil rigPhoto credit: Getty Images

 

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[Ed. note: for a change, we are presenting a post by a stock market bull below, namely Sid Riggs, via Bonner & Partners. It is always refreshing to see a well-reasoned argument that is contrary to one’s own opinion – after all, no-one really knows the future and Sid makes a number of important points, which deserve to be given attention. Sid is actually quite correct with respect to the historical correlation between rate hikes and the stock market. The strongest counter-points we can offer are these: 1. the market is extremely overvalued, 2. long-term positioning data show that everybody is “all in” already and 3. a rate hike would not be the first act of tightening monetary policy, but in fact the third. Act one was the “taper”, act two the cessation of QE. Given the paramount importance of money supply growth to stock prices, we would argue that the decisive factor will be whether or not commercial banks decide to expand credit.]

 

A Powerful Lesson from the Recent Past

There is a lot of lip service being paid to the stock market crash that we’re supposed to expect once the Federal Reserve starts raising rates. Every time we get close to a regularly scheduled Federal Reserve statement, financial pundits pontificate about the nuances of what the Fed chair might say, not say, or imply. It’s like clockwork.

 

 

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No-One is Paying Attention – Yet

Almost exactly one year ago, we penned several articles on what we believed to be a dangerous bubble in corporate debt. The boom in both prices and bond issuance was primarily driven by the desperate “hunt for yield” of investors starved of interest-income by the inane ZIRP and NIRP policies enacted by major central banks all over the developed world.

There is no need to rehash all the arguments we made at the time – as a refresher, readers may want to revisit “A Dangerous Boom in Unsound Corporate Debt” and “Comfortable Myths About High Yield Debt” for the details. So far, the potential dangers we identified at the time haven’t become fully manifest yet, but there are now signs that this may be about to change.

 

i promiseI promise!

Image credit: Minerva Studio

 

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