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Olduvai
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Olduvai III: Catacylsm
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Yesterday’s note caught a lot of attention.
In it, we argued that investing in stocks today based on the Fed getting dovish is like buying stocks after the Bear Stearns deal: you’re buying based on a development that reveals the financial system is in serious trouble.
Remember, the Fed didn’t become dovish for no reason… it because dovish because it sees systemic risk on the horizon.
Corporate America is perched atop a debt bomb of $10 trillion, of which roughly 1/3rd is junk… meaning unlikely to be paid back.
Rather than issuing debt to build factories or expand operations, these companies have been issuing debt to buy back shares, resulting in the system being MORE leveraged today than it was in 2007.
Over $700 billion of this debt comes due this year… at a time when 60% of US companies already have NEGATIVE cash flow.
Put another way, the debt is coming due at a time when most companies don’t have the money to pay it back.
Outside of the US, Europe is teetering on the brink of recession, with the latest industrial production numbers showing a year over year decline of 4.2%. This is the largest collapse since 2009, at the depth of the Great Financial Crisis.
Then there’s China, where despite claims to the contrary, the entire system is collapsing. The Central Bank of China just engaged in the largest liquidity pump of all time last month… meaning it spent MORE money propping up the system in January 2019 than it did at any point in 2008.
If things are fine in China, why is it doing this?
Again, structurally the global financial system is in SERIOUS trouble. Buying stocks today based on the idea that the Fed is not as hawkish as before is like buying stocks because of the Bear Stearns deal.
And deep down, the market knows it.
…click on the above link to read the rest of the article…
A decade after the subprime bubble burst, a new one seems to be taking its place in the market for corporate collateralized loan obligations. A world economy geared toward increasing the supply of financial assets has hooked market participants and policymakers alike into a global game of Whac-A-Mole.
Olduvai IV: Courage
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Olduvai II: Exodus
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CAMBRIDGE – A recurrent topic in the financial press for much of 2018 has been the rising risks in the emerging market (EM) asset class. Emerging economies are, of course, a very diverse group. But the yields on their sovereign bonds have climbed markedly, as capital inflows to these markets have dwindled amid a general perception of deteriorating conditions.
Historically, there has been a tight positive relationship between high-yield US corporate debt instruments and high-yield EM sovereigns. In effect, high-yield US corporate debt is the emerging market that exists within the US economy (let’s call it USEM debt). In the course of this year, however, their paths have diverged (see Figure 1). Notably, US corporate yields have failed to rise in tandem with their EM counterparts.
What’s driving this divergence? Are financial markets overestimating the risks in EM fixed income (EM yields are “too high”)? Or are they underestimating risks in lower-grade US corporates (USEM yields are too low)?
Taking together the current trends and cycles in global factors (US interest rates, the US dollar’s strength, and world commodity prices) plus a variety of adverse country-specific economic and political developments that have recently plagued some of the larger EMs, I am inclined to the second interpretation.
In what is still a low-interest-rate environment globally, the perpetual search for yield has found a comparatively new and attractive source in the guise of collateralized loan obligations (CLOs) within the USEM world.
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