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Most profitable investing take place in the area of medium risk. With higher risks investors often can't stomach losses and sale in the most opportune time. In low risk area you can't beat inflation.
Investors in junk bonds need to deal with Wall Street. The sad truth is, however, that many investors are not well served in their dealings with Wall Street; Wall street in first and foremost is a huge propaganda machine that acts against the interests of common investors in order to enrich the Wall Street Firms. They regularly advice to take too much risk. that means that investors, especially 401K investors they would benefit from developing a greater understanding of the way Wall Street works. That means that they need to stady such social system as corporatism and its latest incarnation -- neoliberalism
The problem is that what is good for Wall Street typically is not so good for investors. As for high quality bonds they sell the general rule is "Interest rate risks can always exceed an investor's time frame in most fixed-income sectors." And Junk bonds is no exception.
But they have contain advantages, if you buy then as specialized mutual funds, not as individual issues. firs of all they have shorter duration, so this risk is proportionally less then for 30 years Treasury bonds. But with junk funds like with stocks timing is everything: they are not suitable target for cost averaging. As PIMCO Gross notes by simply researching historical annual high yield default rates (5%), multiplying that by loss of principal in bankruptcy (60%), and coming up with an expected loss of 3% over the life of future loans. So fair return for junk bonds is LIBOR + 300 or more. In other words as Gross stresses "for LIBOR+250 high yield lenders are giving away money!"
High yield issuance topped $300 billion in 2012. The majority of that was used to refinance existing debt and by the end of 2012, 80 percent of market volume ($1.13 trillion) consisted of bonds sold since 2009. Thirty-two issuers defaulted on $20.5 billion in bonds in 2012, compared with 29 issuers and $15.9 billion in 2011. Fitch believes that the default rate on high yield debt in 2013 would “at least double if the economy slides back into recession or very low growth.” Last year’s riskiest sectors were the paper and pulp industry (7.7% default rate), utilities (10.5%), consumer products (4.7%), transportation (4.4%) and banks (3.3%). From July to year-end, the volume of ‘CCC’ rated new bond issues rose 54 percent and made up 18 percent of overall junk bond issuance.
Beyond pushing out debt maturities last year, high yield borrowers in 2012 saw a decline in their interest rates as demand for their bonds rose and interest rate dropped.
The key question here is whether the economy will go into double dip (as was widely expected in 2010) or not. Junk like some other credit markets have signs of overheating as investors take larger risks in response to the persistence of low interest rates... Recent Fed speech underscored that the Fed increasingly regards bubbles, rather than inflation, as the most likely negative consequence of its efforts to reduce unemployment by stimulating growth with money printing. ...
Citigroup analysts led by Anindya Basu point out that spreads on the CDX HY, as the index is known, are currently pricing in an expected loss of 21.2 percent, which translates into something like 22 defaults over the next five years if one assumes zero recovery for investors. That is a pretty big number once you consider that a total of 41 CDX HY constituents have defaulted since the index really began trading in 2005, equating to about 3.72 defaults per year. A big chunk of those defaults (17) occurred in 2009 in the aftermath of the financial crisis.
What to make of it all? Actual recoveries during corporate default cycles tend to be higher than the worst-case scenario of zero percent. In fact, they average somewhere in the 26 percent range, which would imply 29 defaults over the next five years instead of 41.
So what? you might say. The CDX HY includes but one default cycle, and those types of analyses tend to underestimate the peril of tail risk scenarios (hello, subprime crisis). Citi has an answer for that, too. Using spreads from the cash bond market going back to 1991, they forecast the default rate over the next 12 months to be something more like 5 percent to 5.5 percent. (For comparison, the rating agency Moody's is currently forecasting a 3.77 percent default rate.)
,,,,The Vanguard Core Bond Fund, unveiled in a filing with regulators on Monday, is being billed as an actively managed alternative to index funds like the Total Bond Market fund (VBMFX, VBTLX, BND). Its launch, slated for the first three months of 2016, would coincide with a period of great uncertainty in the bond markets. The Fed could mull its next interest-rate hike as soon as March.
... ... ...
Daniel Wiener, editor of the Independent Adviser for Vanguard Investors newsletter and a close watcher of all things Vanguard, was quick to note that the fund could invest in bonds of "any quality." The new fund's fine print shows leeway for Vanguard's portfolio managers to plunk up to 5% of the portfolio in junk bonds. Some 30% of the fund could fall into "medium-quality" bonds.
Vanguard's existing offering in junk debt, the Vanguard High-Yield Corporate Fund (VWEHX, VWEAX), is managed by Wellington Management Company.
Says Wiener: "Vanguard has never offered lesser-quality bond funds run by its internal group. The junk portion of the Core Bond product will be a first."
peakoilbarrel.comJeffrey J. Brown, 12/13/2015 at 4:06 pmInteresting WSJ article (do a Google Search for the title, for access). Last week, the Journal noted that Chesapeake bonds that traded at 80¢ on the dollar a few months ago were currently trading at 30¢ to 40¢ on the dollar. I suspect that there are some huge losses on the books of a lot of pension funds.
WSJ: The Liquidity Trap That's Spooking Bond Funds
The specter of a destabilizing run on debt is haunting markets
The debt world is haunted by a specter-of a destabilizing run on markets.
Last week, this took on more form even if there weren't concrete signs of panic. Only one mutual fund manager, Third Avenue Management, has said it would halt redemptions to forestall having to dispose of assets in a fire sale. The rest of the industry has been quick to say that while redemptions are elevated, particularly in high-yield bond funds, there doesn't seem to be a rush to for the exits.
Still, growing angst comes as the oil-price rout continues and the U.S. Federal Reserve appears ready to raise rates. This has investors worried-and starting to ask the fearful question: "Who's next?"
Goldman Sachs, for one, put out a note Friday warning Franklin Resources "is most at risk" given the large high-yield holdings of its funds, poor performance and large outflows. On Friday, its shares fell sharply. Meanwhile, there were unusually large declines Friday in the value of exchange-traded funds that track high-yield debt.
The idea of a "run" on mutual funds might sound strange. Typically, runs are associated with highly leveraged banks engaged in maturity transformation, funding long-term loans with short-term debt. Nearly all the programs designed to avoid destabilizing runs-from deposit insurance to the Fed's discount window to liquidity requirements-are built for banks. But unleveraged investors, including mutual funds, can also give rise to runs. That is because there is a liquidity mismatch in mutual funds that hold relatively illiquid assets funded by investors entitled to daily redemptions.
naked capitalismMikeNY December 12, 2015 at 6:41 amtimmy December 12, 2015 at 9:39 am
Yes, junk is usually the canary in the coal mine. The HY market melted in the Summer of 2008, months before equities noticed what was going on. The question really is how much contagion there will be: how many CDS have been written on the distressed names, who holds them, etc. My instinct tells me that there are considerably less CDS on junk than were written on MBS, due to the smaller market, the lower liquidity and (supposed) credit quality. But how much has that changed since 2008? I dunno.
One thing I do know: it's like the movie "Groundhog Day". The Fed always overstimulates, and there always follows a crash. Are there any bubbles left to blow, to 'reflate' assets next time?Jim Haygood December 12, 2015 at 1:39 pm
Your remark on written CDS is important. While it may be difficult to get liquidity on distressed names, it is less so on credit tiers above that or on indices. I'm sure there is some on junk, yes, but the real opportunity for spec CDS is (perhaps, was) on the BBB space which is the largest category in the investment grade market and is more liquid. While it may take awhile for distressed trading to creep up the credit ratings to the larger and more liquid names (specifically, since the definition of liquidity seems to be important on NC: the size of the specific issues' float, approximated with average daily volume), they will also have larger moves because potential fallen angels are repriced aggressively in an unstable market. The other thing about CDS is that they are most often delta-hedged which requires dealers to sell proxy's as the CDS go deeper into the money. The one restraining factor is that once a crisis is in motion, I think its going to be difficult for specs to get more CDS on their books. This strategy is purely directional (this is not an ETF NAV arb), essentially owning out of the money puts with minimal cost of carry.Mike Sparrow December 12, 2015 at 3:48 pm
'Their investing strategy – putting high-risk investments into a mutual fund – seems like exactly what not to do.'
It cuts two ways. Junk ETFs such as JNK and HYG have badly underperformed their benchmarks, owing to buying and selling in an illiquid market to replicate an index. Whereas actively managed junk mutual funds have the flexibility to deviate from index holdings in ways that can add a couple of hundred basis points a year.
That said, both junk ETFs and junk mutual funds are offering daily liquidity, while holding underlying securities that may trade once a week, or have no bids at all. As David Dayen observes, this sets up the risk of a bank run when investors get spooked.
Take a look at the "power dive" chart of TFCIX (Third Avenue Focused Credit Fund) - Aiieeeeee!
Now the question is contagion. Morningstar shows that 48% of TFCIX's portfolio was below B rating, and 41% had no bond rating. Most junk funds don't have THAT ugly a portfolio. But when the herd starts to stampede, fine distinctions can get lost in the dust cloud from the thundering hooves.
Over to you, J-Yel. Do you feel lucky, cherie? Well, do you?Keith December 12, 2015 at 7:27 am
There is no CDS. There just isn't less, there is none. The stock market has pretty much ignored it as well except that its move from 13000 to 18000 has temporarily stalled. I suspect by the spring, this will be old news.
I think we make errors here, not understanding this particular type of financial speculation is "anti-growth" in general. This would probably blow most of the minds on this board.Keith December 12, 2015 at 7:29 am
Many years ago when Alan Greenspan first proposed using monetary policy to control economies, the critics said this was far too broad a brush.
After the dot.com crash Alan Greenspan loosened monetary policy to get the economy going again. The broad brush effect stoked a housing boom.
When he tightened interest rates, to cool down the economy, the broad brush effect burst the housing bubble. The teaser rate mortgages unfortunately introduced enough of a delay so that cause and effect were too far apart to see the consequences of interest rate rises as they were occurring.
The end result 2008.
With this total failure of monetary policy to control an economy and a clear demonstration of the broad brush effect behind us, everyone decided to use the same idea after 2008.
Interest rates are at rock bottom around the globe, with trillions of QE pumped into the global economy.
The broad brush effect has blown bubbles everywhere.
"9 August 2007 – BNP Paribas freeze three of their funds, indicating that they have no way of valuing the complex assets inside them known as collateralised debt obligations (CDOs), or packages of sub-prime loans. It is the first major bank to acknowledge the risk of exposure to sub-prime mortgage markets. Adam Applegarth (right), Northern Rock's chief executive, later says that it was "the day the world changed"
10th December 2015 – "Moments ago, we learned courtesy of the head of Mutual Fund Research at Morningstar, Russ Kinnel, that the next leg of the junk bond crisis has officially arrived, after Third Avenue announced it has blocked investor redemptions from its high yield-heavy Focused Credit Fund, which according to the company has entered a "Plan of Liquidation" effective December 9."
When investor's can't get their money out of funds they panic.
Central Bank low interest rate policies encourage investors to look at risky environments to get a reasonable return
Pre-2007 – Sub-prime based complex financial instruments
Now – Junk bonds
The ball is rolling and the second hedge fund has closed its doors, investors money is trapped in a world of loss.
"Here Is "Gate" #2: $1.3 Billion Hedge Fund Founded By Ex-Bear Stearns Traders, Just Suspended Redemptions"
We know the world is downing in debt and Greece is the best example I can think of that shows the reluctance to admit the debt is unsustainable.
Housing booms and busts across the globe ……
Those bankers have saturated the world with their debt products.Skippy December 12, 2015 at 7:41 am
Links (which will probably require moderation)
Quality of instruments impaired by corruption has a more deleterious effect than quantities of could ever imagine…
David December 12, 2015 at 10:33 amtegnost December 12, 2015 at 10:52 am
"Those bankers have saturated the world with their debt products."
I'm no apologist for Banksters but people bought this "stuff" as the Stuffies.
whether you call it greed or desperation in the face of zero yield – at the end of the day the horizon was short since the last debacle.
getting 2 & 20 or whatever the comp arrangement was for those who are motivated by greed – 2% of $2 Billion yields at least $40 million a year for 5 years or $200 million – not bad for ten guys or less – obviously not fiduciaries – bouncing from Bear to Tudor to Third Ave with no change in the model yields predictable results
I put forth the proposition the "people" deserve their fate – the tea leaves were all there to seeIan December 12, 2015 at 2:24 pm
Your apology is flawed because it assumes equal access to information among investors as well as assuming all investors have the same objective. Institutional investors have different goals than hedge funds for example. The people you refer to have been fleeced that's just ok with you. As to tea leaves the people have been steeped in recovery stories for years.Ian December 12, 2015 at 2:29 pm
Also fails to recognize the collateral damage caused towards the people that did not directly participate. It is very hard to say that they deserve their fate in this context, in that they were largely powerless to stop it to begin with, at a reasonable level.
I guess you qualified that with focusing solely on the people who bought it. Did not read fully.
Timmy December 12, 2015 at 8:34 amJim Haygood December 12, 2015 at 4:25 pm
Wait, so speculators are shorting big bond positions of distressed funds? No way, hope they aren't doing this to ETF's. Jeez, didn't see this coming. I guess having the positions of big ETF's published daily might assist the speculators.Timmy December 12, 2015 at 4:51 pm
Yesterday HYG closed at a 0.76% discount to NAV, while JNK closed at a 0.68% discount (values from Morningstar). These are wider discounts than ETF managers like to see.
The arbitrage mechanism of buying the discounted ETF shares, redeeming them for the underlying, and then selling the bonds at full value for an instant 0.76% gain is supposed to kick in now.
But sell … to whom?tegnost December 12, 2015 at 9:15 am
The misperception is that the ETF junk trade is an arb right now. Its not, its directional. The discipline to bring NAV's in line with underlying value will only kick in at much wider levels because traders are still long (and putting on more of) the "widener" because they anticipate higher levels of vol going forward.
Actually have already been bracing myself as demand for labor fell off a cliff at the end of sept., and I'm guessing it's stories such as this that makes my customers tighten their belts....
nat scientist December 12, 2015 at 9:55 amcraazyboy December 12, 2015 at 4:26 pm
"Some say the world will end in fire
Some say in ice
From what I've tasted of desire
I hold with those who favor (fire) INFLATION
But if it had to (perish) REFINANCE twice,
I think I know enough of (hate) ZIRP RATES
To say that for destruction (ice) NO BID
Is also great
And would suffice."
Marty Whitman now gets Robert Frost.Christer Kamb December 12, 2015 at 1:44 pm
All those junk companies could just declare bankruptcy and start over. That's the way it's supposed to work. Just ask The Donald. Then it would be like that movie where Bruce Willis saved the earth from an asteroid strike. 'Course there was only one asteroid in that movie. Instead, we have World War Z with zombies all over the place!
But maybe JYell will buy all the junk bonds, burn them, and then the dollar will crash and we can all get jobs?MikeNY December 12, 2015 at 4:25 pm
"The HY market melted in the Summer of 2008, months before equities noticed what was going on."
Not really. HYG market were in a downtrend during summer of 2007, together with the stockmarket. Also in the 2008 summer both markets were in a severe meltdown. This time around the HYG´s started their downtrend from summer 2014 with the 1:st leg down to dec same year. 2:nd leg is now running in which the stockmarket joined.
Your right, HYG´s seems to be the canaries here! But, from august this year they seems to go in different directions. Or are they?
You're right, it was earlier than Summer 2008, now I think about it.
What I do remember (and I can't remember whether it was Spring of 2008 or earlier), was that HY spreads had gapped out at least a couple of hundred bps, and equities were still at or near all-time highs. I remember sitting in a meeting with a couple I-bankers, who chuckled ruefully "equities haven't a clue".
The received wisdom on the Street is that the bond market is smarter than the equity market. And, at last in my career, it was true, at least as far as downturns went.
Jul 20, 2015 | Zero HedgeTwo months ago, in "ETF Issuers Quietly Prepare For Meltdown With Billions In Emergency Liquidity," we outlined the rather disconcerting circumstances that have led some large fund managers to quietly line up emergency liquidity facilities that can be tapped in the event of a sudden retail exodus from bond funds.
"The biggest providers of exchange-traded funds, which have been funneling billions of investor dollars into some little-traded corners of the bond market, are bolstering bank credit lines for cash to tap in the event of a market meltdown. Vanguard Group, Guggenheim Investments and First Trust are among U.S. fund companies that have lined up new bank guarantees or expanded ones they already had, recent company filings show," Reuters reported at the time, in a story we suspect did not get the attention it deserved.
At a base level, these precautionary measures are the result of the interplay between central bank policy and the unintended consequences of the post-crisis regulatory regime. ZIRP creates a hunt a for yield and simultaneously incentivizes companies (especially cash strapped companies) to tap the bond market while borrowing costs remain artificially suppressed. Clearly, this is a self-fulfilling prophecy. The longer rates on risk free assets remain near, at, or even below zero, the more demand there is for new corporate issuance (the rationale being that at least corporate credit offers some semblance of yield). More demand means rates on corporate credit are driven still lower, and once yields on high grade issues get close to the lower limit, yield-starved investors are then herded into HY.
All of this supply in the primary market comes at a time when liquidity in the secondary market for corporate credit is non-existent thanks to the shrinking dealer books that resulted from the government's (maybe) well-meaning attempt to crack down on prop trading. The result: a crowded theatre with a tiny exit.
This situation has been exacerbated by the proliferation of bond ETFs which have allowed retail investors to pile into corners of the fixed income world where they might not belong.
All of the above can be summarized as follows.
"MF assets too large versus dealer inventories" (via Citi)...
... clear evidence of "structural damage in corporate bond trading liquidity" (via JP Morgan)...
... and the rapid growth of bond funds in the post-crisis world (via BIS)...
So given the above, the question is this: if something were to spook the market - a rate hike cycle for instance, or an October revolver raid on HY energy names, or an exogenous geopolitical shock - causing an exodus from these funds, what would happen to prices if fund managers were suddenly forced to transact in size in an illiquid secondary market in order to meet redemptions?
"Nothing good", is the answer.
The solution is to avoid selling the underlying bonds - even when investors are selling their shares in the funds.
But how is this possible?
To a certain extent, outflows in one fund can be offset by inflows to another. These "diversifiable flows" are one happy byproduct of the great ETF proliferation. Here's a refresher on how this works courtesy of Barclays.
* * *
Portfolio Products Replace Dealer Inventory
While diversifiable flows limit the risks to portfolio managers in principle, the reality of the high yield market is more complicated. Managers have specific views on tenor, callability, sectors, covenants, and, most importantly, individual credits, such that actually finding buyers for specific bonds can be quite difficult. In the pre-crisis period, dealers ran large inventories that effectively facilitated the netting of flows across funds (Figure 1). A fund with an outflow would sell bonds into the dealer community, and funds with outflows would buy bonds out of the dealer inventory. When inventory is large, the fact that the specific bonds bought and sold did not match was largely irrelevant. Funds with outflows could sell the bonds of their choice, and the funds with inflows could pick investments from the large variety of inventory held by dealers.
The matching problem has become more acute as dealer inventories have declined. Even funds can net flows in principle, dealers are much less willing to warehouse bonds, and are much more likely to buy only when they believe they can quickly offload the risk. Under this scenario, the fact that flows can theoretically be netted is of little practical use to fund managers – actually netting individual bonds is extremely difficult, particularly in the short time frame required by funds offering daily liquidity to end investors.
This is where portfolio products come in. Investors can use portfolio products to fund outflows/invest inflows immediately and execute the necessary single-name bond trades over time as liquidity in the underlying bond market allows (Figure 2). In this scenario, funds with inflows and outflows simply exchange portfolio products, sidestepping the immediate need to trade single-name corporate bonds.
* * *
Ok great, so ETFs provide a kind of "phantom" liquidity if you will. There are two problems with this:
- It only works when flows are diversifiable. Once flows become unidirectional, it all goes out the window.
- It makes the underlying markets even more illiquid.
Here's how we put it last month in "How Fund Managers Use ETF Phantom Liquidity To Avert A Meltdown":
In other words, if I'm a fund manager, the idea that ETFs provide liquidity rests on the assumption that when I experience outflows, someone else will be experiencing inflows and thus I can sell ETFs and avoid offloading my bonds into an illiquid corporate credit market. Put another way: I am depending on new money coming into the market to fund redemptions from previous investors who are exiting the market, all so that I can avoid liquidating assets that are declining in value and that I believe will be difficult to sell. There's a term for that kind of business. It's called a ponzi scheme and just like all other ponzi schemes, when the new money dries up (so, for example, when HY bond ETF flows are all headed in the wrong direction), the only way to meet redemptions is to get what I can for the assets I have and when the market for those assets is thin (as the secondary market for corporate credit most certainly is), I may incur substantial losses.
Note also that the more often ETFs are used as a way of avoiding the underlying bond market, the more illiquid that market becomes, making the situation still more precarious in the event of a panic.
So what is a fund manager to do?
This is where we come full circle to the emergency liquidity lines mentioned at the outset. In order to avoid tapping the underlying illiquid bond market in a situation where flows are unidirectional, fund managers may instead pay out redemptions in borrowed cash.
This is, to quote Citi's Matt King, "creative destruction destroyed."
That is, this represents the willful delay of a long overdue episode of creative destruction layered atop another delay of the much needed Schumpeterian endgame. Stripping out the metaphysics and philosophy references, that can be translated as follows: this strategy is yet another example of delaying the inevitable. If fund managers are forced to tap these liquidity lines it likely means investors have found a reason to sell en masse and if that reason turns out to be something that permanently impairs the value of the underlying bonds (as opposed to a transitory, irrational panic) then all the funds are doing by borrowing to meet redemptions is employing leverage to stave off the recognition of losses, which is ironically the same thing (in principle anyway) that the companies whose bonds they're holding have done to stay in business. It's a delay-and-pray scheme designed to avoid selling the debt of companies whose similar delay-and-pray schemes have run their course.
In closing, it's important to note that no fund manager in the world will be able to line up enough emergency liquidity protection to avoid tapping the corporate credit market in the event of panic selling in the increasingly crowded market for bond funds.
In other words, when the exodus comes, the illiquidity that's been chasing markets for the better part of seven years will finally catch up, and at that point, all bets are officially off.
Economist's ViewStephen G. Cecchetti and Kermit L. Schoenholtz (sort of a follow up on the claim that financial reform is working -- perhaps -- but as noted in the post below this one there is more to do):An Open Letter to Bill McNabb, CEO of Vanguard Group: Dear Mr. McNabb,We find your WSJ op-ed (Wednesday, May 6) misleading, short-sighted, self-serving, and very disappointing.Vanguard has been in the forefront of providing low-cost, reliable access to U.S. and global capital markets to millions of customers, including ourselves. Following the financial crisis of 2007-2009, the firm naturally should be a leader in promoting a more resilient financial system. Your op-ed sadly goes in the opposite direction.Let's start with the most stunning example: your defense of money market mutual funds. MMMFs are simply banks masquerading as professionally managed investment products. Like banks, they engage in liquidity and maturity transformation. Like banks, they faced runs in 2008 that ended only when the federal government provided a guarantee that put taxpayers at risk. Even with that guarantee, the government still had to support many healthy U.S. corporations with household names that – having previously relied on MMMF purchases of their commercial paper – suddenly faced a severe credit crunch. And, to limit a fire sale amidst the crisis, the Federal Reserve had to provide special funding to buyers to help MMMFs unload their assets.Unsurprisingly, fund sponsors and their clients – both creditors and borrowers – want to keep these opaque federal subsidies (especially the implicit guarantees that only become explicit and transparent in a crisis). Like them, you make the false, but popular claim that power-hungry regulators (who wish to limit the subsidies that make future crises more likely) are attacking (taxing!) Main Street instead of Wall Street.In fact, the investment company industry captured its primary regulator long ago, and hasn't let go. The Securities and Exchange Commission's 2014 "reform" of MMMFs is exhibit A. It almost surely makes these funds more, not less, liable to runs (see here and here). And – what a surprise – Congress seems to find protecting U.S. taxpayers from contingent liabilities (like implicit financial guarantees to your industry) less attractive than the largesse of financial lobbyists. Even the voluminous Dodd-Frank Act didn't address MMMFs! :
After quite a bit more, they conclude with:As the CEO of one of the largest mutual fund companies in the world that is dedicated to serving and protecting small investors, you should be in the vanguard of advocating reforms that enhance stability.Instead of complaining about regulation under the guise of protecting Main Street, you should highlight the vulnerabilities in our financial system and make the case for efficient regulation that treats all activities equally. You should also promote investment vehicles that are likely to prove robust in a crisis, while warning about existing products that probably won't be.Only greater resilience in the system can make investors confident that capital markets here and elsewhere will remain strong. That is in Vanguard's interest, too.Sincerely,Stephen G. Cecchetti and Kermit L. Schoenholtzanne -> anne:
Stephen Cecchetti and Kermit Schoenholtz are intent on undermining the most important stock and bond investment vehicle for moderately wealthy investors. Vanguard sets the finest of examples for the entire investment industry.
pgl -> anne:
Maybe you are being paid by Vanguard but you are wrong. You are not qualified to comment on financial economics. Stephen Cecchetti and Kermit Schoenholtz are.
And they are not trying to undermine anyone. They are simply telling the truth. Repeat your garbage all you want but it is garbage.
mulp -> anne:anne:
Anne, unless you call the FDIC bailout of the money market funds, and the Fed providing liquidity to them in 2008-9 totally wrong and you should have suffered losses in your holding in MMMF as they marketed to market (breaking the buck) and froze withdrawals until they could liquidate their holdings, or alternatively, declared bankruptcy, then you are totally bought into the free lunch economics of Friedman, Reagan, and all the bank lobbyists dependent on government handling the losses while they reap the profits.
I remember the debate in the late 60s and early 70s on money market funds. We (the People) were assured that MMFs would never be seen as banks by any one investing in them because everyone would know the MMF would someday lose value and in the process freeze the assets for some length of time until the fund could be liquidated.
In other words, not one person putting money in a MMF would see it as a bank that pays higher interest. More importantly, no business or corporation would ever confuse a MMF with a bank.
In 2008, it is clear that the promises made four decades earlier to allow unsophisticated investors access money market funds without lengthy notice of intent to withdraw funds was all a lie, or a belief in tinker bell, pixie dust, and free lunches.
The money market funds should have been left to collapse in 2008 to destroy all faith in them as safe for individuals to use, and in the process, "destroy trillions in wealth" held by tens of millions of upper middle class workers.
I would have lost more than I did in 2008, but the demand for greater government control of the financial sector plus greater social safety nets would have followed.
This is the first time I've seen someone besides me state that mutual funds are banks as we knew them in the 60s, except they pay nothing for the protection of FDIC and Federal Reserve membership.anne:
May 9, 2015
Fees on Mutual Funds Fall. Thank Yourself.
By JEFF SOMMER
Wall Street is reaping mounting revenue from mutual funds and exchange-traded funds, yet investors are paying lower fees.
That sounds like a good deal for the millions of people who use the funds to invest their savings, and a great deal for the companies that run and sell the funds.
But that win-win situation is not quite as benign as it would seem. Many investors are still - often unwittingly - paying huge fees that cut into retirement savings.
A new Morningstar study offers an excellent explanation of what is happening. The report, "2015 Fee Study: Investors Are Driving Expense Ratios Down," found that, by one measure, mutual fund and E.T.F. fees paid by individual investors had dropped significantly - 27 percent - over the last 10 years. But it isn't mainly because Wall Street fund managers have been reducing fees. The study found that investors have been voting with their feet, moving money from expensive funds into cheaper ones, like index funds. That drives down the asset-weighted cost of mutual funds, skewing the statistics.
"It's not mainly thanks to the efforts of the fund companies," Michael Rawson, an author of the Morningstar study, said in an interview. "It's mainly because people have gravitated toward lower-cost funds."
There's a good reason for the migration to lower-cost funds: They tend to outperform higher-cost ones. As I've written recently, most actively managed mutual funds don't beat the market; those that do beat it rarely manage the feat consistently. Many consumers have gotten the message. Of the 100 lowest-cost funds on the market in March, 95 were index funds that merely try to match the market, not beat it, according to an unpublished study by the Bogle Financial Markets Research Center. Many investors have chosen index funds.
Yet because of the peculiar economics of the asset management industry, fund companies are still doing great. The companies that run the funds have been reaping outsize rewards because as fund assets have grown - thanks in part to the market's terrific performance over the last six years - the companies' own costs have declined.
That's because of economies of scale that the companies don't share fully with customers. "The cost of individual funds has dropped, but the assets have gotten so much bigger that the companies' revenue from fees has grown tremendously," Mr. Rawson said. "They could be sharing more of those revenues with consumers, but they're not."
Using publicly available documents, the Morningstar researchers estimated that in 2014, fee revenue from all stock and bond mutual funds and E.T.F.s reached a record high of $88 billion, up from $50 billion a decade earlier. Assets under management grew 143 percent, and industry fee revenue surged more than 75 percent. The asset-weighted expense ratio - the funds' publicly declared expenses divided by the actual money that investors put into them - declined, too, but only by 27 percent. "The industry - rather than fund shareholders - has benefited most," the report said. Mr. Rawson, a Morningstar analyst, wrote the report with Ben Johnson, director of global E.T.F. research at the company.
The details are fresh, but the economic machine that propels the asset management business has been whirring along for decades. In a telephone interview last week, John C. Bogle, the founder of Vanguard, the industry's low-cost leader, said that in some ways, running a fund company is like operating a factory. As you ramp up production, it becomes cheaper to produce additional items because important costs - fixed costs - don't rise.
For an asset management company, he said, a stock or bond portfolio is the core product and the intellectual exercise of selecting stocks and bonds for it is a fixed cost. "When you set up and run the portfolio, it's not much more expensive to do it when your fund has, say, $1 billion in assets, than when it had only $30 million," Mr. Bogle said.
"Unless you cut your fees drastically, you're going to generate a lot more money for your company as assets grow," Mr. Bogle said. "But do you think the industry wants you to understand that? Absolutely not. Most fund companies aren't passing those savings on to investors."
Vanguard, which is owned by shareholders of its funds, passes along most of the savings. Morningstar found that Vanguard's average asset-weighted expense ratio in 2014 was 0.14 percent, lower than any of the other top asset management companies and lower than 0.64, the current asset-weighted expense ratio for all funds.
Mr. Bogle says companies should charge a modest, flat fee for setting up a portfolio - not a percentage of assets, charged annually, which is the current practice - and give fund investors the rest of the money. That would not generate the splendid profits that asset management companies and their owners have enjoyed, however.
No wonder that in a rising market, shares of publicly traded asset management companies tend to outperform their own stock portfolios. For example, since the beginning of March 2009, the start of the current bull market, through April, the stock of BlackRock, the giant E.T.F. company, returned 27.1 percent, annualized, compared with 20.8 percent annualized in the iShares Core S&P 500 E.T.F., a BlackRock fund that tracks the Standard & Poor's 500-stock index, according to Bloomberg. You would have been better off investing in BlackRock, the company, than in its own S.&.P. 500 index fund.
Why should mutual fund and E.T.F. investors care about the economics of fund expenses? Because it's the dark side of compounding, a force that can be magical when it works in your favor:.
Vanguard 500 Stock Index Fund
Average annual returns as of 3/31/2015
3/31/2014 ( 12.56%)
3/30/2012 ( 15.93)
3/31/2010 ( 14.29)
3/31/2005 ( 7.89)
08/31/1976 ( 11.05)
Vanguard Long-Term Investment-Grade Bond Fund
Average annual returns as of 3/31/2015
3/31/2014 ( 14.54%)
3/30/2012 ( 8.42)
3/31/2010 ( 10.34)
3/31/2005 ( 7.49)
07/09/1973 ( 8.71)
anne -> anne:
This is what Vanguard has meant for modestly wealthy conservative long term investments since the 1970s. From Warren Buffett to David Swenson, the chief investment officer at Yale, Vanguard has been the recommended vehicle for ordinary stock and bond investors.
Harming Vanguard would be a tragedy.
anne -> anne:
"Harming Vanguard would be a tragedy."
The point is harming Vanguard would be harming the ordinary investors who in effect own Vanguard since Vanguard is indeed a "mutual" fund company, a company owned by fund investors.
Dan Kervick -> anne:anne -> Dan Kervick:
The well-being of modestly wealthy long-term investors is only one factor to consider in relation to the well-being of the entire US and global economy. Shouldn't we broaden the discussion?
Vanguard forms a model for investment well-being in the United States.
Anne, having liquidity requirements is not a tax on investors. When McNabb represents it as such, he is lying. There are no new fees or taxes imposed. It just requires that stock funds hold a percentage of assets in safe bonds in order to handle redemptions in panic situation rather than rely on taxpayer bailouts.
Investors are still entitled to 100% of the returns from the fund. Yes, it is true that the total return may be somewhat less because bond returns are typically less than stock returns. However, that isn't a tax or fee on investors.
Almost no investors maintain a 100% stock portfolio. The typical investor my have anywhere from 20% to 80% bonds. So with the liquidity proposal, some portion of the bond assets they hold anyway will be in their stock fund. They can adjust their stock vs bond allocation accordingly, taking into account the bonds held in their stock fund. After this adjustment, they will receive exactly the same total portfolio return as previously.
The idea that this is a tax or fee is simply a lie. Investors still receive 100% of their investment return.
Dan Kervick -> anne:
JohnH: I don't believe Vanguard needs any liquidity requirements because none of its investments use leverage. If money is needed, they would just sell the assets at the current market value and disburse the proceeds.
Well, it seems prima facie plausible that the ability of some firms to deliver very high returns at low cost is due to the amount they have invested in high-risk, high-yield assets. An economy filled with many such firms is going to be an economy with a higher level of systemic risk. If we want a financially safer world, then some rich people are going to have to get richer much more slowly than they did in the past.
MMMFs are a little different, because there is the presumption that that value of each share will always be $1, which it will be if short term treasuries are kept to term. In case of a run, the Fed could also buy the treasuries and keep them a few weeks to maturity, as they do under QE.
For funds that use leverage, the risk of a run is entirely different:
My interpretation of Anne's issue is that she simply favors individualism's credo for the "moderately wealthy" over the rest of our society, and rationalizes her position by believing (in faith) that Vanguard is immune to failure and thus would not be a participant in any new liquidity meltdown, ergo the nation's taxpayers should shoulder the burden of for profit financial investors when such financial markets fail.
I'm not sure what Anne's position is/was related to the meltdown just past.. but she's caught on the horns of dilemma --- either taxpayer's bail out private investors or they suffer an even greater financial and economic calamity.
The whole point of Cecchetti & Schoenholtz open letter is that a) Vanguard is not immune, and b) taxpayers should NOT be placed on the horns of that dilemma again, and thus the Vanguard letter was indeed self-serving and misleading.
EMichael -> Longtooth:
Well, the critiques may be technically accurate enough as far as they go.
But I fail to see how attacking one of the last pockets of low-fee, consumer-facing investment helps anyone in the long run, except those who wish to herd all money into complex, opaque, high-fee vehicles.
Money Market "reform" may have found some reasonable-sounding talking points on which to promote itself, but stepping back, one cannot help but see it is simply one more wave in the voracious plunder and elimination of any and all alternatives to the relentless and jealous Wall Street flim flam machine.
A democratic investment company is a company that is investor owned, that offers the finest quality long term stock and bond funds with minimal transactions or turnover at low management cost for investors with $10,000. For those men and women who prefer to deal with a Goldman Sachs, a suggest giving that company a call and finding the difference.
The idea that a Warren Buffett is paid by Vanguard for recommending Vanguard only shows a failure to understand that Vanguard is owned by investors and there are no payments made to financial advisers for recommending the company.
DeDude -> anne:
If you think the leadership if Vanguard is controlled by and serving its investors - then you need to get out of the Ivory tower a little more.
Leadership in any Wall Street company are always serving themselves first, second and third. It is just that some of them are better at hiding that fact than others.
As much as Vanguard is trying to sell itself as the investors friend on Wall street, their leadership is just as much a part of the Wall street vampire tribe as the rest of them. Yes, they suck less less blood from each victim, but they are still blood-suckers. When I see Vanguard offering a fund that restrict its investments to companies that compensate CEOs less than average (for that industry and size), then I will know they have left the blood-sucker tribe. The one product that would truly serve the interest of investors is not available from any investment company, because as useful as it would be for us it is dangerous for them.
The descent to profane and violent language on this thread, the descent to intimidation and bullying, is intolerable, horrifying, and meant only to destroy this thread and this blog.
EMichael -> anne:
Personally, I think the constant repetition of a Edwardian rant about language is "intolerable, horrifying, and meant only to destroy this thread and this blog."
As Keynes said, "words ought to be a little wild".
Syaloch -> EMichael:
Amen to that.
Syaloch -> anne:
Am I missing something? Neither "vampire" nor "blood-sucker" is profanity -- unless you mean it in the sense of blasphemous, i.e. criticism of something sacred.
Do you think that this "class of people" who work on Wall Street are holy deities and therefore beyond reproach?
You attitudes toward Vanguard certainly seem to point in that direction:
anne -> Syaloch:
These very terms were used to characterize and dehumanize a class of people in the 1930s. These are terrible, fearful terms to use to describe and stereotype people.
The use of profanity and a metaphor from the 1930s in describing a class of people is intolerable. Paul Krugman made a serious mistake in using a 1930s metaphor in description, both for the dismissing of the decency of the humanness of an entire class of people and for setting an example as to use of the metaphor.
Millions of people were methodically murdered during the 1930s in the wake of a campaign to stereotypically deny their decency, to deny their humanness by using dehumanizing metaphors to describe them.
likbez -> anne:
While behavior that you mentioned are unacceptable, a part of the blame is on you: you demonstrated a perfect example of the psychology of rentier, Anna.
Rentier capitalism is a term used to describe the belief in economic practices of parasitic monopolization of access to any kind of property, and gaining significant amounts of profit without contribution to society.
No, I think people are just having a little fun with your stuttering failure to address the issues. However, I will stop now (before being called a Nazi again – but don't think your bullying has worked, its just that I am tired)
DrDick -> DeDude:
Nothing I love more than passive-aggressive bullies, but that is Anne's schtick.
The key question to Anne is whether Vanguard is really better for unmanaged funds then ETFs. You need to provides us with solid evidence or all your post with belong to the category that Prince Hamlet defined as:
The lady doth protest too much, methinks.
And for managed funds Vanguard experienced several high profile disasters such as with their flagship Primecap fund around 2008. In this sense there is not much to talk about here. Thir managed funds is just a typical example of "go with the crowd" approach.
Issue of fees was important in 90th. But now IMHO Vanguard belongs to "also run" category: for each Vanguard fund you probably can find other fund or ETF with comparable fees.
So why you so adamant in defending Vanguard Anne? It' just one of Wall Street sharks which was broght to the surface by establishing 401K in 1978
P.S. I also consider Vanguard to be among more decent category of Wall Street sharks. But it is still a shark.
Apr 11, 2015 | Zero Hedge
Submitted by Raul Ilargi Meijer via The Automatic Earth blog,
That title may be a bit much, granted, because never is a very long time. I might instead have said "The American Consumer Won't Be Back For A Very Long Time". Still, I simply don't see any time in the future that would see Americans start spending again at a rate anywhere near what would be required for an economic recovery. Looks pretty infinity and beyond to me.
However, that is by no means a generally accepted point of view in the financial press. There's reality, and then there's whatever it is they're smoking, and never the twain shall meet. Admittedly, my title may be a bit provocative, but in my view not nearly as provocative, if not offensive, as Peter Coy's at Bloomberg, who named his latest effort "US Consumers Will Open Their Wallets Soon Enough".
I know, sometimes they make it just too easy to whackamole 'em down and into the ground. But even then, these issues must be addressed time and again until people begin to understand, and quit making the wrong decisions for the wrong reasons. People have a right to know what's truly happening to their lives, and their societies. And they're not nearly getting enough of it through the 'official' press. So here goes nothing:
US Consumers Will Open Their Wallets Soon Enough
People are constantly exhorted to save, but as soon as they do, economists pop up to complain they aren't spending enough to keep the economy growing. A new blogger named Ben Bernanke wrote on April 1 that there's still a "global savings glut." Two days later the Bureau of Labor Statistics announced the weakest job growth since 2013, which economists quickly attributed to soft consumer spending.
The first problem with Coy's thesis is that even if people open their wallets, far too many of them will find there's nothing there. And Bernanke simply doesn't understand what savings are. His ideas through the past decade+ about a Chinese savings glut were always way off the mark, and his global – or American – savings glut theory is, if possible, even more wrong. In the minds of the world's Bernankes, there's no such thing as people opening their wallets to find them empty. If they don't spend, they must be saving. That there's a third option, that of not having any dollars to spend, is for all intents and purposes ignored.
The U.S. personal savings rate-5.8% in February-is the highest since 2012. "After years of spending as if there were no tomorrow, consumers are now saving like there is a tomorrow," Richard Moody, chief economist at Regions Financial, wrote to clients in March. Saving too much really can be a problem when spending is weak.
The little man inside, when I read things like that, tells me this is nonsense. So I decided to look up how the US personal savings rate is calculated. Turns out, it's another one of those whacky goal-seeked government numbers. At least, that's what I make of it. Mainly, though not even exclusively, because of things like this, from a site called Take A Smart Step:[The personal savings rate in] November 2012 was 3.6%, this is not even close to where we need to be for financial health. This savings rate barely gives us enough to handle emergencies, and makes us as a nation weaker. The government calculates the personal savings rate as the difference between the after tax income and consumption of Americans. So they include not only retirement savings, but debt repayments, college savings, emergency fund savings, anything that was not spent.
Making paying off your debt (i.e. money you've already spent) count towards your savings is a practice fraught with questionable consequences. But useful for economists, and accountants alike, no doubt. The problem with it is that it hides reality behind a veil. Because debt repayments are not really savings at all; people are not free to spend what they put into paying off debt, on something else, like iPads, cars or trinkets. Not even on hookers or crack cocaine, for that matter.
For the vast majority of what is paid off in debt, there's no such thing as free choices. People pay off debt because they must. Or, to look at it from another, wide lens, angle, Americans would have to stop servicing their debt payments if they want to 'start spending' again.
Going through the numbers from various sources, I can see that the US personal savings rate is presently some 5.8% of pre-tax income, and debt repayment is close to 10% of disposable -after tax – income. I'm still trying to make those stats rhyme. But no matter how you read and interpret them, it should be clear that debt repayments are a large part of 'official' savings. Even if they really shouldn't be counted as such.
Of what remains in real savings, retirement/pension savings must necessarily be a substantial percentage, and it would be weird to call those things 'saving like there is a tomorrow', if only because they are about, well, tomorrow. But that seems to be the new normal: creating the impression that saving any money at all is somehow detrimental to the economy. A truly crazy notion, if you ask me. Let's get back to Bloomberg's Coy:
There are only two things you can do with a dollar, after all: spend it or save it. If you spend it, great-that's money in someone else's pocket.
In someone else's pocket, but no longer in yours. Why would that be so great? It's only great if that someone has added value to something by doing productive work, not if you simply swap paper assets.
If you save it, the financial system is supposed to recycle your dollar into productive investment with loans for new houses, factories, software, and research and development.
That notion of 'the financial system is supposed to' refers to theories such as those that Bernanke and his ilk 'believe' in. Theories that have no practical value. What is normal for many everyday Americans is crippling debt levels, and no such thing is recognized in these theories. After all, according to them, whatever amount of dollars you get in, you either spend or save them. And if you use them to pay off previously incurred debt, you're supposedly actually saving, even though you no longer have possession of the money in any way, shape or sense, nor a choice of what to spend it on.
But if no one's in the mood to invest more and interest rates are already as low as they can go (as they are in much of the world), the compulsion to save can sap demand and throw people out of work. For the U.S. economy, the good news is that the jump in the personal savings rate is probably no more than a blip. Three economists from Deutsche Bank Securities in New York explained why in a March 25 report called 'U.S. Consumers: Still Shopping, Not Dropping'. While noting a "deceleration" in consumer spending, they wrote, "we think that concerns about the outlook for the consumer are overstated." Their model of the U.S. economy predicts the savings rate will fall to 3% to 3.5% by 2017.
Oh sweet lord. Now a falling savings rate has become a beneficial thing, even when and where savings are very low. Not saving will allegedly save the economy. How did that happen? If we may presume that debt repayments will continue virtually unabated, and there seems to be little reason to think otherwise, this means that by 2017 there will be just about nothing saved at all anymore in America. Which means there'd be very little left of the 'If you save it, the financial system is supposed to recycle your dollar into productive investment'.
The only 'growth' perspective America has left is to grow its debt levels continually, continuously and arguably exponentially.
Other economists have also concluded that the spending dropoff is temporary, which is why the slowdown in job growth, to just 126,000 in March, didn't set off many alarm bells. "Consumer spending is starting to look more and more like a coiled spring," says Guy Berger, U.S. economist at RBS Securities. One sign that consumers aren't retrenching: On April 7 the Federal Reserve reported that consumer credit rose $15.5 billion in February, in line with the recent past.
They got deeper into debt, and this is a sign they're not 'retrenching'? A coiled spring? Really?
According to Deutsche Bank Securities, the first reason to think consumers will resume spending is that their incomes are rising. Annual growth in average hourly earnings has averaged about 2% since 2010, which isn't great but does exceed inflation. With more people working as well, aggregate payroll outlays are up 4.9% from the past year, according to Bureau of Labor Statistics data.
The rises in stock and home prices should make consumers more willing to live a little, say the Deutsche Bank authors. They calculate that households' net worth is almost 6.5 times consumers' disposable personal income. That's the highest ratio since before the housing crash.
But that last bit is arguably all due to QE induced asset bubbles. Not an argument the author would make, I know, but nevertheless. Coincidentally, another Bloomberg article published the same day as the one we're delving in here is called:Why Your Wages Could Be Depressed for a Lot Longer Than You Think. Perhaps the respective authors should have a sit down.
No question, the high savings rate depresses spending in the short run. Purchases of durable goods, from cars to couches, remain well below their 60-year average share of GDP. But all that saving helps consumers get their finances in order, which will allow them to satisfy pent-up demand for that sweet new Ford F-150.
No no no: they just paid off part of their debts. How can that possibly mean they'll go out and get a new F-150? In real life, they spent their money instead of saving it. Either way, they don't have it any longer to spend on a F-150. It would mean they need to get into new debt. On top of what they still have left over even AFTER paying down part of it.
Fed data show that financial obligations including debt service, rent, and auto leases are about their lowest in comparison to disposable income since 1981.
Hmm. According to Wikipedia, "Household debt as a % of disposable income rose from 68% in 1980 to a peak of 128% in 2007, prior to dropping to 112% by 2011." It's about 105% today. So that's just a very weird statement. Someone's wrong, very wrong, and I think I know who that would be. Maybe Peter Coy conveniently ignores mortgage payments when he talks about "financial obligations including debt service, rent, and auto leases"?!
When consumers are ready to borrow more, it won't hurt that, according to the Fed's survey of banks' senior loan officers, banks are easing lending standards.
See? That's what I said: they can only spend if they acquire new debt. They're just getting rid of the last batch, and it's going mighty slowly at that. Lest we forget, when debt as a percentage of income falls, that is due to quite an extent to people failing to make any debt payments at all, and losing their homes and cars. This is a dead economic model. This model is pining for the fjords.
These factors add up to an optimistic consumer.
Oh, c'mon. What is that statement based on? That 'sky high' savings rate that is really just poor slobs paying off what they can in debt repayments so they won't get hit with even more fees and fines?
What I think these factors add up to, is a delusional reporter. There is no excess saving. It's ludicrous. As far as people have any money at all, they're using it to pay down their previously incurred debts. And that gets tallied into their savings rate by the government's creative accounting methods. That's all there is to the whole story. But it will, regardless, induce a few more poor souls to sign up for more mortgages and car loans and feel like happy American consumers on their way down into the maelstrom.
It's sad, it really is. Maybe we should first of all stop referring to the American people as 'consumers'. That might help.
Mar 19, 2015 | Zero Hedge
The biggest issue facing the financial system today is the US Dollar rally.
The Fed and other Central Banks are trying to maintain the illusion that they have everything in control by talking about interest rates, but the reality is that the US Dollar carry trade is ABOVE $9 trillion in size. That is almost as big as ALL of the money printing that occurred between 2009 and 2013.
And it's imploding as we write this.
Globally, the world is awash in borrowed money… most of it in US Dollars. The US Dollar carry trade is north of $9 trillion… literally than the economies of Germany and Japan COMBINED.
When you BORROW in US Dollars you are effectively SHORTING the US Dollar. So when the US Dollar rallies… you have to cover your SHORT or you blow up.
And the US Dollar has been rallying… HARD. Indeed, the move that began in July 2014 is already larger par in scope with that which occurred during the 2008 meltdown.
Moreover, this move has occurred with little to no rest. The US Dollar barely corrected 2% after rallying a stunning 16+% in a matter of months before beginning its next leg up.
You only get these sorts of moves when the stuff hits the fan. CNBC and the others are babbling about the Fed's FOMC changes, but all of that is just a distraction from the fact that a $9+ trillion carry trade, arguably the largest carry trade in history, has begun to blow up.
Rate hikes, QE, all of this stuff is minor in comparison to the carnage the US Dollar is having on the financial system. Take a look at the impact it's having on emerging market currencies.
... ... ...
Mar 18, 2015 | Zero HedgeThere was a time when Zoltan Poszar was the most important person at the Fed (and Treasury), because he was likely the only person in the government's employ who grasped the enormity and complexity of the then-$30 or so trillion US shadow banking system. A quick refresh of his bio from the Institute for New Economic Thinking:
Mr. Pozsar has been deeply involved in the response to the global financial crisis and the ensuing policy debate. He joined the Federal Reserve Bank of New York in August 2008 in charge of market intelligence for securitized credit markets and served as point person on market developments for senior Federal Reserve, U.S. Treasury and White House officials throughout the crisis; played an instrumental role in building the TALF to backstop the ABS market; and pioneered the mapping of the shadow banking system which inspired the FSB's effort to monitor and regulate shadow banking globally. Prior to Credit Suisse, Mr. Pozsar was a senior adviser to the U.S. Department of the Treasury, where he advised the Office of Debt Management and the Office of Financial Research, and served as Treasury's liaison to the FSB on matters of financial innovation. He also worked with the Federal Reserve Board on improving the U.S. Flow of Funds Accounts.
While Zoltan is currently working in the private sector at Credit Suisse, he is perhaps best known for laying out, back in 2009, the full topographical map of the US shadow banking system in all its flow of assets (or is that contra-assets when it is a repo) beauty.
Which is also why we bring him up, because in a much welcome follow up to his previous work title "A Macro View of Shadow Banking" which we will discuss further in the coming days because it is not only Zoltan's shadow banking magnum opus and must read for anyone who wants to get up to speed with all the latest development in the unregulated shadow banking space, but because Poszar also provides perhaps what is the most important chart which explains why the Fed is so very terrified of even the smallest possible incremental rate hike of 0.25%.
Specifically, we look at Poszar's findings about the implied leverage within the fixed income asset space in America's just a little levered buyside community. This is what he says:
Although no precise measures are available, the presence of leverage among hedge funds with credit and fixed income strategies has been recognized since the LTCM crisis (see Figure 21), as is leverage in separate accounts in the asset management complex.
While hedge funds and separate accounts are allowed to use leverage liberally – in fact, leverage is the sine qua non of these investment vehicles – it is widely underappreciated that bond mutual funds that are typically thought of as unlevered and long-only also have considerable room to use leverage.
The extent to which this room to use leverage is utilized is up to bond portfolio managers to decide, and it is not uncommon for the largest bond funds to maximize the leverage they may bear in their portfolio within the limits allowed by the Investment Company Act of 1940, and the SEC's interpretation of the portfolio leverage and concentration incurred through the use of derivatives.
However, the creep of leverage into what are traditionally thought of as long-only bond funds was missed by the mainstream economics literature and textbooks entirely. For example, recent works that identify asset managers as the core intermediaries behind the "second phase of global liquidity" focus solely on indirect forms of leverage (FX mismatches) embedded in bond portfolios through holdings of dollar-denominated emerging market sovereign and corporate bonds (see Shin, 2013).
Other works state even more explicitly the widely-held assumption that fixed income mutual funds are unlevered, and analyze episodes of market volatility induced by redemptions without any regard to how direct forms of leverage embedded in fixed income mutual funds may amplify volatility during periods of rising redemptions (see for example Feroli, Kashyap, Schoenholtz and Shin, 2014, Chapter 1 of the International Monetary Fund's October 2014 Global Financial Stability Report, Chapter 6 of the BIS' 84th Annual Report, and Brown, Dattels and Frieda, 2014 (forthcoming)).
But all of these views sit uncomfortably with the hard evidence presented above, and recent revelations about "perceived" alphas (see Gross, 2014b) and price action in the interest rate derivative markets amidst soaring redemptions from the largest bond portfolio in the global financial ecosystem – the PIMCO Total Return Fund (see Mackenzie and Meyer, 2014). More concretely, a look at the portfolio of this specific fund provides good examples of the forms of leverage discussed above.
More broadly, the above example demonstrates the evolution of the traditional core product of the asset management industry – long-only, relative-return funds – as it came under pressure from two directions: from hedge funds, offering absolute return strategies, and from passive index-replication products in the form of low-cost exchange traded funds (ETFs). Core-satellite investment mandates became the trend, with hedge funds providing alpha and index-replication vehicles delivering beta at low cost. Traditional asset managers responded to this challenge a number of ways: some by launching their own, internal hedge funds, and some by incorporating into their core products many of the alternative investment techniques used by the hedge funds. These industry trends were the sources of competitive push that drove the above-mentioned creep of leverage into the industry's traditional, long-only, relative-return bond funds (and hence the rise of levered betas), all designed to stem the flow of assets to the hedge fund competition and command higher fees as the profitability of traditional core products was squeezed (see Bank of New York, 2011 as well as Haldane, 2014).
In short, what Poszar is saying is that in a world in which the traditional broker-dealers and banks have indeed reduced leverage and instead use $2.5 trillion in Fed reserves as fungible collateral against which to buy credit derivatives (for example as in the case of JPM's CIO office and its attempt to corner the IG9 market) the buyside community, which as we have long discussed has largely avoided equities due to fears of a spectacular market implosion (and certainly minimized levered exposure in the space with the exception of several prominent HFT participants) has instead been forced to chase after fixed income products. And chase with leverage that would make one's head spin as can be seen in the outlier chart above.
And while Poszar may be quite correct in stating that most have missed the leverage creep he observes above...
Perhaps the key reasons why economists have missed the creep of leverage into the traditionally long-only world of fixed income mutual funds are the conceptual gaps in the way in which the U.S. Financial Accounts (formerly the Flow of Funds) depict the global financial ecosystem, and by extension, the limited mental map it gives to economists who use it to understand asset prices.
... one entity that does understand all this and grasps the momentuous implications of even the smallest quantum of interest rate increase, is the entity where Poszar previously worked: the US Treasury and the Federal Reserve itself.
And so, the next time someone asks "why is Yellen so terrified of even the smallest possible rate hike", show them this chart above and explain that the Fed vividly remembers what heppened when LTCM blew up. What the Fed doesn't want, is not one but one thousand LTCMs going off at exactly the same time in what is now the world's most levered trade...strannick
So the dollar isnt going up because of America's sound fundamentals? But rather because its newly minted QE is being used to make leveraged, unhedged gambling bets in derivatives markets (ie. CDOs that cant be paid by counter parties like AIG to losers like MF Global) by primary dealers as repo collateral instead of being released into the economy and increasinging the money velocity?
So the Fed is lying when they say they will soon raise interest rates? Even though raising interest rates .25 % would add 100s of billions in interest to the over 18 trillion dollar debt?
So there is a quadrillion dollar hidden -shadow- banking system beyond the site of Congress and investors at large? That is potentially worse than a 1000 Lehmans?
So then shouldn't we be using our overvalued dollars to buy suppressed under valued gold
I found this helpful:
Crap... It's just like the movie SPEED with Sandra Bullock and Keanu Reeves back in '94 when a former banker rigs a bus loaded with muppets to explode unless he get's paid a million$$ ransom.
If Yellen let's the speed fall below 50 MPH then the bomb goes off and everyone dies.
Meanwhile she's desperately looking for an off-ramp called ECONOMIC GROWTH but it ain't there... and now she's running out of road and there's a hole in her gas tank...
we look at Poszar's findings about the implied leverage within the fixed income asset space
Do you have any idea what the avg rate on the 10 year bond is?
Of course it is about leverage, it has always been about leverage. There are two ways for control freaks to fight a deleveraging: 1) print money, and 2) re-lever. And since the fixed income markets are by far the largest, guess where the leverage (mostly in the form of swaps) was placed?
And in order to keep this leverage from blowing up, interest rates have to stay zero, forever. This is not rocket science. Neither, however, is it reality, but that is what they are trying to do.
1. Average all-time historical return is 0 or negative. Inflation beyond a few tenths of a percent only became a standard phenomenon during the industrial age. This is one of the key points of metallism and one of the reasons monetarists and chartalists (more like charlatans) hate metallism.
2. Savers should not have their money in the bank (or brokerage) if they don't want the banks to use it.
To my knowledge the long-run average coupon on government debt in all places was 3%-5% or less, it was the preferred asset class (in addition to farmland, of course) of the rentier parasites of recent centuries. This high rate is part of why we got national income taxes; careful what you wish for.
There is no point in calling fiat currency stolen, any more than there is in calling a unicorn stolen. It is all debt, not money. The theft begins as soon as it is loaned into existence. Beyond that, the interest means it by nature requires theft from the future.
wake up! look at the jefferies numbers of the other day. it is nearly impossible for banks to make money under these conditions. sure they saw some MTM on their rates books back in '10/11/12, but the rest of "earnings" for years running has been from mark-to-fantasy, headcount reductions, buybacks, offshoring, and loss avoidance (delaying foreclosures and repossessions on NPLs). this the-Fed-is-saving-the-banksters meme, while popular, doesn't fit the observable realities. fed policy is--as tiny timmah geithner confessed--the best progressive economics in action.
it is direct monetary financing of our bloated federal government. when you see a person doing something most people infer the motivation for the action is the reward for the action. in the case of the fed we need to adjust our optics to understand they are doing things not to be rewarded but to avoid consequences (like the Dutch boy with his finger in the dike, no Yellen pun intended). what would happen if they allowed a return to market economics?
the federal government would have to fund its ever growing shortfall in the rates market. that would probably be possible at first, but the higher rates would slow the remains of the "economy", which would increase demand for services AND retard tax receipts, which would increase the funding shortfall, which would push up rates, which would choke the economy, which would...well, you get the picture. without the Fed, the overlevered federal candy machine would quickly tear itself apart.
I think the Fed is going to try to raise in order to re-set the shock absorbers before the coming sell off in order to maintain at least the illusion they can stimulate the economy. but it is too little, too late. we will quickly be back to the Fed protecting the politicos by trying to slow the collapse. (to keep this simple I have avoided the obvious asset-inflation scheme as a tool to keep large donors happy, but even analyzing that will bring you back to the same place: the Fed must protect the politicians or die trying.) this is the slow motion death rattle of America's nanny state.
This is a very popular view, but it is wrong. We are talking about fractions of a percent. Declining oil prices have given them an undeserved window, in which to begin normalization.
It's true there is no exit strategy. There never was. This is their one last chance to let market rates emerge without complete chaos. They are too stupid to take it. Unfortunately, the consequences will fall on us all.
The FED has over 4 Trillion on their balance sheets now compared to 852 billion in 11/08.. The US Government has over 17 Trillion dollars of debt compared to 9.23 Trillion in 11/08... need I say more? That is unless they don't have to pay interest> Were all Japanese now and if inflation forces the 0% interest Ponzi to raise interest rates you might just as well bring the whole herd of deer out Tyler because it will be carnage
9/11 Truth: Judges shocked by first time seeing video of WTC 7 collapse in Denmark court
"Magic" number 7
US is run by gangsters. Greatest criminal enterprise ever conceived in the history of man.MATA HAIRY
The hellicopters will come but they won't be dropping money.
Some folx ain't waitin till September..
coming to a theater near you.
Frankfurt (AFP) - Violent clashes between anti-capitalist protesters and German police left dozens injured and a trail of destruction in Germany's financial capital as the European Central Bank opened its new headquarters Wednesday.
Draghi, addressing some 100 invited guests at a low-key ceremony, rejected blame for the suffering brought by budget cuts and austerity policies amid the financial crisis in Europe.kchrisc
um...those are europeans rising up against their masters. Not americans.
Americans are cattle and will never do so. At least white americans never will.yogibear
"There was a time when Zoltan Poszar was the most important person at the Fed (and Treasury), because he was likely the only person in the government's employ who grasped the enormity and complexity of the then-$30 or so trillion US shadow banking system."
The FedRes is NOT a part of the governmnet, but a PRIVATE branch of the PRIVATE Zionist banking cabal that owns and controls the DC US.
The FedRes only wants to comprehend the ramifications of their actions the same as a thief does. And like a thief, they wish to keep their loot, and to remain free to thieve more in the future.
The banksters need to repay us. Guillotine the Fed. Audit the heads.
LOL, the Federal Reserve can't raise rates.
Just BS the markets for months and later years.
The markets may have just figured it out.
Nov 21, 2014 | Bloomberg
Junk bond investors have a bad case of the jitters. Every bit of bad news is whipsawing prices, with bonds tumbling as much as 50 percent in a single day.
"We've seen some flash crashes in the market," saidHenry Craik-White, a senior investment analyst at ECM Asset Management in London, which oversees $8 billion. "If you get caught on the wrong side of a name, you can get severely punished in this market."
Investors are rattled because they're concerned that a lack of liquidity in the bond market will make it impossible for them to sell holdings in response to negative headlines. Trading dropped about 70 percent since 2008, with a corporate bond that changed hands almost five times a day a decade ago now only being sold once a day on average, according to Royal Bank of Scotland Group Plc.
Alarms started ringing in September with the collapse of British retailer Phones 4u Ltd. after Vodafone Group Plc and EE Ltd. refused to renew contracts. The retailer shut its business and sought creditor protection on Sept. 15, sending the company's payment-in-kind bonds down to 1.9 pence on the pound, according to data compiled by Bloomberg.
Nov. 30, 2014 | money.cnn.com
One man's junk bonds might be another man's treasure.
Dramatic swings in the junk bond market often provide a valuable warning to investors. During times of turmoil, investors pile into ultra-safe U.S. government debt and rotate away from far riskier junk bonds.
That swing away from junk bonds often happens shortly before stock market downturns.
"High yield does provide useful sell signals to equity investors," Barclays analysts concluded in a recent report.
Barclays combed through the past dozen years of data. The warning signal they found is a 30% or greater increase in the spread between Treasuries and junk bonds before a dip.
History is a guide: Consider 2002. The "spread," or gap between the yields of junk bonds and Treasuries, spiked in July that summer after WorldCom defaulted on its debt and US Airways signaled it was filing for bankruptcy.
Investors who sold stocks based on the turbulence in the high-yield debt market would have escaped a 14% nosedive in the S&P 500 over the next 10 days.
"Had equity investors heeded the warning being sent from high yield, significant losses may have been avoided," Barclays wrote.
While the stock market bounced back from that 2002 episode pretty quickly, the same can't be said about when the sell signal was triggered five years later.
Junk bond spreads surged in June 2007 as two Bear Stearns hedge funds dropped a bomb on investors about massive losses in subprime mortgage assets.
Despite the alarm bells ringing in the credit markets, the S&P 500 set all-time highs as late as the fall of 2007. But then stocks began a long descent as it came to light that many more firms had similar subprime mortgage problems.
Many investors clearly wish they listened to that early warning from junk bonds.
Barclays said equity investors should "position defensively" the next time junk bonds start to go haywire. That doesn't necessarily mean dumping stocks altogether. After all, the stock market eventually bounced back from each of the sell-offs Barclays examined.
Instead, lower volatility sectors like consumer staples and utilities could provide investors with cover during a potential storm. The analysis found that after the sell signal was triggered, these sectors outperformed higher-turbulence ones like materials and energy.
Bottom of oil prices is not seen yet. Last time in 1986 oil fall $35 to $10. Most of the damage in oil price decline behind us. But not oil speculators were washed out.
Marginal producers will go out of business. They are highly leveled and they will have problems in refinancing their debt. There will some ripple affects on financial market. Increased volatility is probably coming in 2015. Fed intend to raise rate.
High yield bond market will be affected.
Lehmann: Yes. We watch the market and the diversity of securities in that market. And we try to stay diversified. But one of the things about the preferred market is that it's really quite complex. We've identified seven different categories of what's called preferreds.
And the majority of the preferreds are actually bonds. They're not stock at all. Then you have your foreign preferreds, which get dividend treatment just like a common stock in the U.S. There is a real diversity of selection, which is one of the reasons our newsletter is quite successful. Because it addresses that market and points out these differences.
Forbes: In terms of the high-yield bonds, junk bonds as we call them, you make, again, a counterintuitive case that the huge issuance which some people thought of, "Oh, my gosh. This is a bubble out there." You say, "Well, in many cases, that's actually a sign of strength."
Lehmann: Yes, I do. I think that people aren't doing their homework when they malign the high-yield market. Because they look at these spreads between investment grade, below investment grade in the past and they say, "Well, no, these spreads are so small now that the risk is not counted in."
But I think the risk is dramatically changing by all this new issuance. Because you have to look at, really, the purpose for the bond issue, not just who's issuing it. And if a company is issuing high-yield bonds at lower interest rates to replace, for example, existing dead issues or to replace bank loans, that's a tremendous strength in the other balance sheet.
Because it gives them more borrowing capacity from the banks in the future if and when they need it, and when they can't issue bonds anymore. So, actual survival chances are greatly enhanced by this volume of new issuance. The junk bonds were high risk when they were being used to make risky new acquisitions or to buy back stock. But when you're using it to buttress your balance sheet, the way it's being done today, I think that there's a real positive to the market.
Forbes: You also make an interesting case, and you cite Bank of America, where the credit rating agencies end up giving a low grade, even though in reality it's investment grade.
Lehmann: Yes. This is sort of a technical factor that distorts the market, where because somebody like Bank of America, that has four or five tiers of debt, different levels of seniority, those levels are rated by the rating agencies based on their claim in a bankruptcy situation, which would make sense except if you say, "Well, Bank of America isn't going to go into bankruptcy. And it's an A-rated at the top" So, you look at it and you say, "Well, that's their chance at bankruptcy," which is pretty close to nothing. And therefore, why wouldn't you invest in their lower-rated paper? Because you're not worried about their claim in bankruptcy and you can collect an extra 100 – 200 basis points of yield.
Forbes: You make the point that in some of these companies, look at what the senior debt is rated at and that, in effect, is what you should look at the junior.
Lehmann: Well, that's what we tend to do. We think that the term junk is really detrimental to making an investment decision. They're anything but junk.
Forbes: High-dividend stocks: You think there are some that we should look at. Everyone says go for dividends. But you make the point 2% versus 6%. But there are some like Altria that you think are worth looking at. Are there other ones? Altria do you still like?
Lehmann: There are quite a few. The tobacco companies are good. Some of the shipping companies, some of the LLPs and the master limited partnerships. These are all good categories, especially when you're concerned about interest rates going up. They offer a lot more protection than a fixed-rate 30-year bond, for example.
Forbes: One of the things you make the point in terms of comparing junk and investment-grade bonds is that results are skewed because investment-grade bonds have a longer maturity than traditional junk bonds do.
Lehmann: Yes. That's one of the things. We don't tend to look at the maturity of the issues so much because in the case of high-yield bonds and in the case of our audience, which is individual investors, they're not buying a bond necessarily to hold it to maturity. They're buying it because it's a good yield now. But their life span is not going to be the length of that bond issue. They're in a different analysis position relative to what they want to buy.
Forbes: Municipal bonds, which covers a multitude of sins.
Lehmann: Of sins, yes.
Forbes: How do you look at munis today?
Lehmann: For my audience, I've always discouraged them from buying municipal bonds. Because I think that your investment decision should be based on rates of return that you can achieve. For years, I was mystified as to why retired individuals and such who were in a very low tax category were buying municipal bonds.
And somebody finally gave me an explanation of why they do that. And it's basically, they say, "I want to simplify my life. I don't want to have to worry about making a tax return and having a big payment in April. I just take all this tax-free income and I don't have to file a tax return."
Well, that's the worst reason I could think of to buy municipal bonds. And as we've seen over time now, the quality of municipalities is deteriorating significantly. And I don't think the market really reflects tha
Forbes: Let's quickly hit - because a lot of people do buy these things, even if for the wrong reasons - your quick assessment of Detroit, the proposed settlement there.
Lehmann: I think Detroit is a real beginning of what may turn out to be a wave of similar-type situations. There is new ground being broken in terms of Chapter 9 bankruptcies in that case. And a lot of municipalities, I'm sure, are sitting on the sidelines watching this and saying, "Does this become a viable option to me?"
But I think more importantly is the fact that for all of these municipalities, the unions, who are usually the major claimants in this situation because of pension and health care, unfunded benefits, they need to watch this very closely. Because we're seeing that their rights are being terminated and having to be renegotiated. And they are going to be much more flexible, I think, to avoid a Chapter 9 bankruptcy than they have been in the past. And so that's probably one of the positives that's going to come out of the Detroit bankruptcy.
Forbes: Another large issue out there: Puerto Rico. Is that still a wing and a prayer? There's over $70 billion of issuance.
Lehmann: Puerto Rico, there's no question that that is going to end up as a tragedy. There is no way that they can meet that debt level. And it's only a question of the mechanics of, basically, how they will shorten off the debt. We see that this last bond issue and the market was very receptive to it.
But if you probably looked at who was buying that, it was the people who were looking at that bond issue as generating the funds by which they can make the interest payment on their $70 billion. Because the amount that was put out was just about what was needed for that. And I don't know how many times you can play that game. But eventually, even with all the reforms that the new governor is promising, it's just gotten way beyond the capabilities of the island to service that debt.
Forbes: So, would you tell individuals, "Lick your wounds and fight another day"?
Lehmann: I would say to them, "Look very closely at any municipal funds you hold and how much Puerto Rico paper is in there. Because it's going to take a major hit." And the same for tobacco bonds.
Forbes: I'm going to ask you about tobacco bonds, another thing, you might say, going up in smoke.
Lehmann: Yes. That's one of those where the original basis for the issuance of many of these bonds was a study that was done in the '70s when this agreement was reached. When the original agreement was reached here, some projections about cigarette consumptions over the next 30, 40 years were made.
And, of course, making a five-year projection, never mind a 40-year projection, is ridiculous. But the market needs something. And they all signed onto this thing. And now we're seeing that cigarette consumption is dropping at a much greater rate than anybody had projected. And many of them are zero-coupon issues. And, consequently, those people are just trading in paper that will never pay off at maturity.
Forbes: A lot of people live in Florida. What about the so-called dirt bonds?
Lehmann: The dirt bonds is kind of a controversial thing there. Most of the dirt bonds were bought by mutual fund families and they didn't do a hell of a good job of scrutinizing.
Forbes: Just to explain, these are housing developments.
Lehmann: Yes. These are community development districts, or housing developments, where any developer can go out and buy 1,000 acres of land, get a mortgage on it, and get all his money out of it, and then issue a $20 million bond issue or a $50 million bond issue to build infrastructure.
This was going hot and heavy in Florida until 2005, when, of course, the collapse came in the real estate market. And they continued to build out and spend all that money because they had raised it and they didn't have any money in the deal. They'd taken their investment out through the bank loans. And, so, when they finished the infrastructure deal and it got to the point where they would have to start paying the assessments, they all said no. They let the thing default. And it has been laying in limbo. And you would've thought there would've been a wave of lawsuits as a result of that. But the mutual funds that bought these bonds were so exposed themselves for having bought them in the first place without really doing a good due diligence exam of this thing. Because it should have been obvious earlier that this was going to end badly.
Forbes: You add it up all together, Detroit, Puerto Rico, tobacco bonds, dirt bonds.
Lehmann: A lot of money.
Forbes: Munis are a minefield.
Lehmann: Tobacco bonds alone is $100 billion. That's a huge chunk of the market. Puerto Rico is $70 billion. These are just the big ones. There are hundreds of municipalities with unfunded pension liabilities and health care who are in the same boat, just their numbers are smaller.
http://www.zerohedge.com/news/2014-09-26/its-dollar-stupid To claim that this is the market at work makes no sense anymore. Today central banks, for all intents and purposes, are the market.
Our overall impression is that the Fed has given up on the US economy, in the sense that it realizes – and mind you, this may go back quite a while - that without constant and ongoing life-support, the economy is down for the count.
And eternal life-support is not an option, even Keynesian economists understand that. Add to this that the "real" economy was never a Fed priority in the first place, but a side-issue, and it becomes easier to understand why Yellen et al choose to do what they do, and when.
When the full taper is finalized next month, and without rate rises and a higher dollar, the real US economy would start shining through, and what's more important - for the Fed, Washington and Wall Street - the big banks would start 'suffering' again.
07/25/2014 | zerohedge.com
As we have been highlighting for a few weeks, something is rotten in high-yield credit markets. This week, the mainstream media is starting to catch on as major divergences in performance (high-yield bond spreads are 30-40bps off their cycle tights from just prior to MH17 even as stocks rally to new record highs) and technicals weaken.
However, as BofA warns, flows follow returns and this week saw the biggest outflows from high-yield funds in more than a year. Investment grade bonds saw notable inflows as investors chose up-in-quality, rather than reach-for-yield, for the first time in years... equity investors, pay attention.
High yield credit markets have been overvalued for a record period of time...
On Tuesday, analysts at Ned Davis Research recommended that investors begin to sell high-yield bonds, partly because they look pricey and partly because performance has been flagging. "Investors are no longer being compensated for the additional risk in high-yield bonds," they wrote.
High yield credit markets are majorly diverging from stocks...
"Geopolitical risk is causing a pause," said Frank Ossino, senior portfolio manager at Newfleet Asset Management in Hartford, Conn., which oversees $12.9 billion. Investors tend to flee riskier assets during times of turmoil.
High yield credit markets are suffering major outflows...
Outflows from high yield funds and ETFs accelerated last week to $2.46bn following a sizable $1.85bn outflow in the prior week. Both of these outflows are the largest since the "taper tantrum"episode in the summer of last year.
"We're not seeing massive outflows yet, but at some point that's going to change," warned Phil Blancato, chief executive at Ladenburg Thalmann Asset Management, which oversees about $2 billion.
He said he is steering clear of high-yield exchange-traded funds in large part due to concerns about how they will fare in a downturn.
* * *
Between a sudden shift to a preference for "strong" balance sheet companies over "weak" balance sheet companies (the end of the dash for trash trade), and this rotation from high-yield to investment-grade, it is clear that investors are positioning defensively up-in-quality ending the constant reach-for-yield trade of the last 5 years.
Why should 'equity' investors care? The last few years' gains in stocks have been thanks massively to record amounts of buybacks (juicing EPS and also providing a non-economic bid to the market no matter what happens). This financial engineering - for even the worst of the worst credit - has been enabled by massive inflows into high-yield and leveraged loan funds, lowering funding costs and allowing CFOs to destroy/releverage their firms all in the goal of raising the share price.
Simply put - equity prices cannot rally for long without the support of high-yield credit markets - never have, never will - as they are both 'arbitrageable' bets on the same capital structure. There can be a divergence at the end of a cycle as managers get over their skis with leverage and the high yield credit market decides it has had enough risk-taking... but it only ends with equity and credit weakening together. That is the credit cycle... it cycles.
Jeff Gundlach was right.
2014-04-30 | Bloomberg
The U.S. drive for energy independence is backed by a surge in junk-rated borrowing that's been as vital as the technological breakthroughs that enabled the drilling spree. While the high-yield debt market has doubled in size since the end of 2004, the amount issued by exploration and production companies has grown nine-fold, according to Barclays Plc. That's what keeps the shale revolution going even as companies spend money faster than they make it.
"There's a lot of Kool-Aid that's being drunk now by investors," Tim Gramatovich, who helps manage more than $800 million as chief investment officer of Santa Barbara, California-based Peritus Asset Management LLC. "People lose their discipline. They stop doing the math. They stop doing the accounting. They're just dreaming the dream, and that's what's happening with the shale boom."
... ... ...
"Who can, or will want to, fund the drilling of millions of acres and hundreds of thousands of wells at an ongoing loss?" Ivan Sandrea, a research associate at the Oxford Institute for Energy Studies in England, wrote in a report last month. "The benevolence of the U.S. capital markets cannot last forever."
The spending never stops, said Virendra Chauhan, an oil analyst with Energy Aspects in London. Since output from shale wells drops sharply in the first year, producers have to keep drilling more and more wells to maintain production. That means selling off assets and borrowing more money.
"The whole boom in shale is really a treadmill of capital spending and debt," Chauhan said.
Access to the high-yield bond market has enabled shale drillers to spend more money than they bring in. Junk-rated exploration and production companies spent $2.11 for every $1 earned last year, according to a Barclays analysis of 37 firms.
"It's a perfect set-up for investors to lose a lot of money," Gramatovich said. "The model is unsustainable."
Many top bond investors, including Doubleline's Jeffrey Gundlach, believe high-yield bonds are overvalued after a long run.
Vanguard High-Yield Corporate Fund Admiral Shares
- Symbol: VWEAX
YTD 1 Yr 3 Yr 5 Yr 10 Yr +3.26% +5.63% +8.41% +14.60% +7.06%
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.
When Blackstone's global head of private equity, Joseph Baratta, said Thursday night that "we" were "in the middle of an epic credit bubble," the likes of which he hadn't seen in his career, he knew whereof he spoke.
Junk bond issuance hit an all-time record of $47.6 billion in September, edging out the prior record, set in September last year, of $46.8 billion, according to S&P Capital IQ/LCD. Year to date, issuance amounted to $255 billion, blowing away last year's volume for this period of $243 billion. The year 2012, already in a bubble, set an all-time record with $346 billion. This year, if the Fed keeps the money flowing and forgets about that taper business, junk bond issuance will beat that record handily.
Junk-bond funds got clobbered in July and August as retail investors briefly opened their eyes and realized what they had on their hands and fled, and they went looking for yield elsewhere, but there was still no yield in reasonable places, and so they held their noses and picked up these reeking junk-bond funds again. Cash inflow doubled over the last week to $3.1 billion, the most in ten weeks.
These retail investors were fired up by the Fed's refusal to taper even a little bit, giving rise to the hope that it might actually never taper, that this is truly QE Infinity, Wall Street's wet dream come true – on the theory that the Fed is mortally afraid that any taper would blow over the sky-high financial-markets house of cards it has constructed over the last five years. And the retail cash returned to these junk-bond funds and just about refilled the hole that had been dug during the summer.
"The cost of a high-yield bond on an absolute coupon basis is as low as it's ever been," explained Baratta, king of Blackstone's $53 billion in private equity assets. Even the riskiest companies are selling the riskiest bonds at low yields. The September frenzy hit the upper end too and set a new record: companies sold $145.7 billion in investment-grade bonds in the US. And Baratta complained that valuations "relative to the growth prospects are out of whack right now."
These "growth prospects" look grim, with corporate revenues barely keeping up with inflation, and with earnings growth, despite all-out financial engineering, getting decimated. On October 1 last year, earnings estimates for the third quarter 2013 still saw a growth of 15.9%. As of Friday, estimated earnings growth had plunged to 4.6%, dropping 20 basis points per week in August and 10 basis points per week in September. And they may still be too optimistic.
Meanwhile, earnings growth estimates for the fourth quarter have barely budged since August and remain at the deliriously lofty level of 11.1%, pulled up largely by financials, whose earnings growth is still pegged at a breath-taking 25.7%, based on the assumption that the Fed will continue to feed them.
But financials are having some, let's say, issues. The five biggest banks alone face a $1 billion cut in earnings from just the past month, based on a big decline in fixed-income trading revenues – with our special friend, JPMorgan, eating more than half of it. There had been "hopes of a final trading flurry in the last few weeks of the quarter," the FT observed, but those hopes have now been squashed.
Then there is the death of the mortgage refi bubble that has been hammering banks, with number one mortgage lender Wells Fargo suffering the most. Four banks have so far announced 7,000 layoffs in their mortgage divisions. JPMorgan confessed that it would lose money in its mortgage business in the second half. On top of that, JPMorgan is contemplating $11 billion in legal settlements for its various mortgage scams. And earnings at financials are still expected to grow 25.7% in the fourth quarter?
"Out of whack" is what Baratta called this phenomenon of sky-high valuations in relationship to grim growth prospects.
Earnings estimates have been slow in coming down. And the stock market, supposedly forward looking and focused on corporate revenues and earnings, has been completely blind to them. It follows the mantra that fundamentals no longer matter. All that matters is the Fed. A shift that has become the Fed's most glorious accomplishment. And the Fed continues to feed Wall Street with $85 billion a month.
Yet in this glorious environment where there is no gravity for stocks and even junk bonds, the smart money is selling hand over fist, unloading whatever they can, however they can. Record junk bond issuance is just one aspect.from Mexicosusan the other
October 1, 2013 at 5:31 am
It looks like one of the consequences of QE has been to drive investors into increasingly high-risk investments in quest of yield. I don't see how this can end well.
Our current era seems to resemble the 1890 to 1914 era in many ways, poised as it was on the precipice of three decades of world-wide war and depression. When the rentier's quest for yield blows up in their faces, the quest for scapegoats will begin.
As Jacques Barzun asks in From Dawn to Decadence,
how can it be that in retrospect the period was seen as an ideal time deserving to be called la belle epoque? … Here it is enough to say that the intellectual and artistic elites, and to a certain extent high society, lived in their world of creation, criticism, and delight in the new. They were aware of the crises, no doubt, but after one or two had gone by gave little thought to what they might still cause. At any rate, those engaged in high art and science took little notice.
The haughty ignorance of social and political facts enables us to understand why the cultivated classes reacted as they did when war came: several hundred intellectuals in Germany signed a manifesto denouncing "the other side" as if betrayed by a friend and brother. It was immediately answered, with a like rhethoric, by several hundred of the French. The enemy's purpose must be wicked since we are innocent.
Overnight, en masses like so many sheep, they turned into rabid superpatriots….
Looking over the roster of great names in literature, painting, music, philosophy, science, and social science, one cannot think of more than half a dozen or so who did not spout all the catchphrases of absue and vainglory….
Freud wrote of "giving all his libido" to Austria-Hungary. The historians and social scientists - Lamprecht, Meinecke, Max Weber, Lavisse, Aulard, Durkheim, Tawney - all found in the materials of their field good arguments in praise of war or reasons to excoriate the enemy. Arnold Toynbee wrote volumes of atrocity propaganda…
And everywhere the clergy were the most rabid glorifiers of the struggle and inciters to hatred. The Brotherhood of Man and the Thou Shalt Not Kill were no longer preachable…. They enlisted God: "He is certainly on our side, because our goals are sinless and our hearts are pure."
The most moderate said: "Kill but do not hate." One English preacher spoke of "the wrath of the Lamb" and another speculated that although Jesus would not have become a combatant, he would have enlisted in the Medical Corps.Moneta
Right. And it is still just as terrifying to know that history dictates, proves, that we are all totally nuts.MikeNY
The market is forward looking in pricing positive or negative delusions. I regularly look at page 21 of this report: http://research.stlouisfed.org/publications/net/ The market has a hard time noticing drops in earnings. It usually takes a few quarters of dropping corporate profits to GDP before the market really reacts. Right now, the ratio is still at an all-time high so we probably still have a few more quarters of optimistic delusions… but the debt market is usually faster on the trigger.Code Name D
Functionally, the Fed believes that the only cure for a burst bubble is a bigger bubble - so this comes as no suprise. They appear to be wilfully blind that, in an era of plutocratic concentration of wealth, the old supply-side nostrums don't work.
The economic model is broken, and until we have a large redistribution of wealth in America, it will stay broken. The bi-partisan focus on 'growth' is a red herring, a distraction, so that we don't have a conversation about the real problem.TimR
But they don't believe in bubbles. Any more than they believe in evolution, global warming, or that the poor can only afford to take weekend trips to the Bahamas.Moneta
…"before the Fed turns off its crazy money spigot"
"if the Fed keeps the money flowing and forgets about that taper business"
"And the Fed continues to feed Wall Street with $85 billion a month."
I'm still confused about QE. In a recent podcast with Stephanie Kelton and Warren Mosler (at neweconomicperspectives.org ), Mosler says, IIRC "..but QE doesn't flood the market with money." He describes QE as (correct me if I'm wrong) just shifting assets from the banks' savings account at the Fed, to their checking account at the Fed (although these accounts are called Treasuries and Reserves, they amount to savings/checking accounts.)
In the Randy Wray podcast (also at newecon), he says if QE ended, there would be a brief turmoil in the markets, and then investors would realize it didn't really make any difference.
Mosler also says that far from increasing the money supply, QE actually *removes* money from the economy, by turning interest-bearing assets into non-interest-bearing assets. And just because they're more liquid, doesn't mean people will run out and spend them into the economy. (One question I have on this aspect of it: what mechanism lets the Fed convert other parties' bonds to reserves, is it voluntary or involuntary for those bond-holders?)
I'm still looking for a really lucid source that describes in detail what's going on with QE. Mosler is great but I can't find an article by him drilling down into some of the details that are still unclear to me.
But posts like this throw me off, given Mosler's seeming authority and expertise. Is Wolf Richter just speaking in some shorthand, or does he not know what he's talking about wrt QE?Dan Kervick
The Fed decides to buys MBS… Pimco might be the seller… then Pimco ends up with cash which permits it to buy something else… government bonds, newer MBS, high yield, etc? So part of this money ends up in the economy and another part moves around across pension plans.
With low velocity, I would say that a lot of this money is just flowing up into the large DB plans.Moneta
Right, but because that MBS that once belonged to Pimco now belongs to the Fed, that cash flows attached to the MBS that would have gone to Pimco go to the Fed instead. So over time, about as much money is drained out of the private sector to the Fed as was injected into the private sector by the Fed's purchase.susan the other
Not really because the new security that replaces the MBS has coupons also. Furthermore, if those MBS were backed by delinquent mortgages, no money would have been flowing anyway. Also, because the pension plans got propped up, pension benefit cheques are still being sent to retirees.
However, one thing is for sure, money is getting parked…
instead of having dollars move hand to hand, government must generate more dollars of debt to generate GDP.Sufferin'Succotash
But the bottom line is that capitalism, not just our brand of gangster capitalism, is dead in the water. Capitalism relies on skimming from somewhere – excessive growth; trashing the environment; screwing labor, etc. Nothing is going to revive it now. We are "in crisis" because the old economy is useless and we will be here for a long time, years, maybe decades. So what's a Fed Head to do? Just keep the money circulating as much as possible. Life support. It is, however, a life support system that left out all but the very rich. So it will not save them either. Poetic justice. And Congress? Forget it.markf
The situation resembles that editorial cartoon back in the late 1920s showing an endless belt with money flowing from Germany to France as reparations, from France to the US as repayment of war debts, then from the US back to Germany as loans.
Something in it for everybody (snicker)!craazyboy
"I'm still confused about QE."
You're not alone.
I've read articles by people explaining in incomprehensible (to me) detail, either why it's great, or why it's terrible.
and none of them seem to be able to write an explanation without using words and acronyms that I suspect many people don't understand.
They're talking to each other I suppose.
my simple question is, who is getting the credits, the money, and what are they using it for?
Where's it ending up? Is it going into the stock market?
is there a simple, layman's explanation for this? without any insider jargon?Moneta
"The Fed Winged It"participant-observer-observed
QE is good if it props up confidence and stops the world from imploding (which it did) but is bad if it generates a drop in confidence by squeezing out industry (which it is increasingly doing).
Go look at the balance sheets of the large consumer discretionary stocks over the last 1-2 years, compare it to the stock prices and tell me that their activity inspires confidence in future economic growth.markf
DIY QE education via "Quantitative Easing Explained" with 5.6 million views since 11/2010!
And "Quantitative Easity Revisited"
I wonder if NC readers find anything false in these.Code Name D
"I'm still confused about QE. In a recent podcast with Stephanie Kelton and Warren Mosler (at neweconomicperspectives.org), Mosler says, IIRC
"..but QE doesn't flood the market with money." He describes QE as (correct me if I'm wrong) just shifting assets from the banks' savings account at the Fed, to their checking account at the Fed (although these accounts are called Treasuries and Reserves, they amount to savings/checking accounts.)"
Ha ha! That's a good one. The guy probably even believes it too.
Creating money is actually quite easy. *Poof* I just created a million Dubies. Want to see me do it again? *Poof*, another million Dubies. But the trick is getting some one to take my Dubies in trade for goods and services. In fact, my Dubies can't even be called a currency until they are accepted as a medium of exchange. I haven't actually made any Dubies, until I spend them into existence.
But there is another quirk here. If I was to accept a Dubie in exchange for something, as I was the originator of the Dubie, then the Dubie poofs into the same nothingness from whence it came. And this would only make sense, if I can create Dubis at will, than by definition a Dubie must have zero value to me. So every Dubie I take back, regardless of what I do with it later, effectively removes it from the economy.
Thus the amount of currency in circulation becomes a balance equation; if I spend more Dubies than I accept in trade, then the supply of Dubies is growing in the broader economy.
For the good old US of A, the one who poof's US dollars into existence isn't the US Treasury as you might think, but the Federal Reserve. This is why the government has this national debt because they have to schlep it like the rest of us.
So when the Fed "buys" any thing; from toilet paper for the office to trillions in mortgage backed securities, it is buying it with dollars that were poofed into existence. Regardless of the mumbo-jumbo they try to peddle about over-all balance sheets.
That gives you the fed's side of the story. But with Quantitative Easing, there is the other side of the store that is told by the too-big-too-fail-banks.
The Fed's theory about "the liquidity crises" is that the banks had a ton of assets that had temporally been devalued in price, thanks to the "great recession". (Snic- oh you just got to love that spin.) But once the recovery takes hold, and the economy is always in recovery, than all of those mortgage backed securities will snap back in value, and even start turning a profit again.
So to tide things over, the Federal Reserve basically buys bank-generated assets, such as mortgage backed securities, and holds them for later. When things recover, the Fed will start selling the assets back to the bank. So they aren't running those printing presses to cause the next Weimar Hyperinflation… oh no this is only temporary. See how clever they are?
Of course, now the 2B2F banks have an incentive to create worthless paper assets, knowing full well the Fed will buy them – no questions asked. And the FED doesn't risk any thing because it's the one that created to dollars in the first place. Indeed, they seem to have a preference for the junk as they are the only ones who will buy it. The Federal Reserve has basically become the consumer of last resort. The banks then have all that brand new free cash to play with which they can used to go gambling in the great global casino called the stock market. Or better yet, they can use those new dollars to create even MORE worthless assets with which to sell to the fed.
That is basically what is happening. The rest of the mumbo-jumbo you hear is just gibberish to try and obfuscate and conceal that this is actually happening, or more likely in an effort to puff themselves up and make themselves look… well…competent. All though I suspect they set there self delusionary image a lot higher than that. It's good to have goals I suppose.
So where is the hyper-inflation you may be asking? Well, it turns out that you don't create hyper-inflation by simply flooding the market with a currency you just printed. Why this is… is complicated. It's also some what off topic.
But there is another explanation. As I said before, a currency has to be spent into existence. But the fed isn't actually spending it, but rather simply making transfers in exchange for fiscal assets that are as equally made up. The 2b2fb take their new cash and "invest" them into other paper assets, which are also fabricated from out of thin air, and which value expands only because other 2b2fb are taking their new Fed cash and trying to buy the same paper assets.
Because the banks are basically creating assets to be sold to the fed, the 2b2fb have basically become a defacto extension of the fed. And like the fed, every dollar the 2b2fb take in – effectively disappears from the economy, regardless of what their balance sheet shows or how they chose to invest it in the stock market or other speculative bubbles.
Despite all the talk of Taper, the reality is that the fed CAN'T stop quantitative easing or the whole thing will simply implodes. But nor is all of the new fed money contributing to the economy because its all going to making more money through financing.
"Mosler also says that far from increasing the money supply, QE actually *removes* money from the economy, by turning interest-bearing assets into non-interest-bearing assets. And just because they're more liquid, doesn't mean people will run out and spend them into the economy. (One question I have on this aspect of it: what mechanism lets the Fed convert other parties' bonds to reserves, is it voluntary or involuntary for those bond-holders?)"
Well Mosler is not entirely wrong, but not for the reason he states. (FYI: Interest baring assets do not add currency to the economy.) Remember that balance sheet equation? If the fed spends more money than it takes in, then it is expanding the money supply. But if the 2b2fb have become extensions of the Federal Reserve because they in effect create money out of thin air, then they also have the consequence of destroying the money that they take onto their balance sheets. It then becomes a question of weather the 2b2fbs are spending more money then they are collecting.
As for the last part of your question… I have…. no clue.Moneta
"Despite all the talk of Taper, the reality is that the fed CAN'T stop quantitative easing or the whole thing will simply implodes."
Of course, that's the best reason for stopping it. Do it now, or do it later, with later being much worse.Walter Map
The debt situation is worse now than it was in 2008. So if the Fed did not let stuff default then, why would it start now?
IMO, the Fed taper will depend on the ROW crumbling first.skippy
And the stock market, supposedly forward looking and focused on corporate revenues and earnings, has been completely blind to them. It follows the mantra that fundamentals no longer matter. All that matters is the Fed. A shift that has become the Fed's most glorious accomplishment. And the Fed continues to feed Wall Street with $85 billion a month.
Since 2008, Obama's policies and the Fed's policies have succeeded in reinflating the financial industry at the cost of an enormous amount of debt. The status quo has been preserved, but the real economy has been cannibalized and not restored. There have been no reforms, ensuring a repeat of the 2008 meltdown at an even greater scale. Wall St. is more out-of-control than ever.
Debt will allow you to ignore the fundamentals and put off the reckoning, but only for so long. That time is running out, and the rats are cashing in and jumping ship:
But now the smart money is scrambling to issue paper … before the Fed turns off its crazy money spigot
This will all end in tears.Moneta
Something about rumor control a la Jim Rickards and any next event requiring an IMF SDR thingy… ouch.MikeNY
Many seem to think that QE was for the elite only. But it has also been for the benefit of the top 10-15%. Those with a pension.
90% of DBs are something like 30% underfunded. Without QE, I can imagine how many write-offs they would have had to do. How even more underfunded plans would have been.
Then, some propose having the government print, print, print without issuing debt… makes one wonder what these underfunded plans would buy! More corporate bonds based on easy printing? If we chose to go this route, chances are all plans would have to go pay-as-you-go. That would mean HUGE upheaval in the markets. The people would hate the elite even more… revolutions often start when the top 10-15% get angry but these QEs have been neutering them.Moneta
The benefit of QE to pension funds depends on the asset mix. Equities have recovered, but fixed income yields have evaporated. So the Fed is forcing pension funds into a riskier asset mix (equities, alternative investments) as opposed to traditional I-grade corporates and treasuries.
I suggest QE is merely kicking the can wrt to pension funds, because what QE has done is to accelerate a decade or more of equity gains into the last couple of years. The hope was that the economy would attain "escape velocity" and justify the multiples and historically high profit margins.
As Ben Inker at GMO has written, this hope is justified only if the majority of American willingly embrace serfdom.minimus
Yup. But they still got another good 4-5 years of bond gains and bailouts and QE propped up equities. It has probably given most DB pensioner n extra 5-10 years of benefits.
With no bailouts and QE, there would have been write-offs in bonds and equities would not have moved up as much. DB plans would have had to cut.
The reality is the leaders do not want to be the ones telling the top 10-15% that they are broke. They will do whatever it takes to just let it happen through what appears like market forces. That's what is great with being able to blame a central bank, it's impersonal.
Also, they probably intuitively know that the real trouble will come when those DBs go bust.allcoppedout
Credit bubbles are marked by the use of a ton of leverage in the corporate sector, usually in the form of a wave of mega-LBOs. In the late 1990s and in 2005-2006, there was a new giant LBO announcement splashed across the front page of the Wall Street Journal practically every other day. That was a tell-tale sign of a credit bubble, a sign that was followed by a collapse of the credit markets in 2001-2002 and in 2008-2009. The absence of mega-LBOs in the current market suggests we are not in a credit bubble.
But I can see why this guy Baratta is complaining. In a "normal" environment, he would take a company private at a low multiple to EBITDA, use cost-cutting and fast economic growth to grow EBITDA, and then sell the company back to the public at a higher multiple. Boo hoo, multiples aren't low enough to ensure he will double his money at every one else's expense. Too bad.
I like the idea of there being a simple answer to QE or the world financial system. Let's face it, economics must be simple or the buffoons we elect wouldn't be able to understand it.
In principle QE sounds like it matters where you stack your money, almost as if moving it around the vault has some kind of 'astrological effect' on the real economy. Anyone who believes this should send their life savings to ACOPONZI (Cayman Offshore Secure Holdings) Inc before Jupiter next blinks. Send with complete power of attorney – we don't want regulatory red tape getting in the way of profits …
In ACOPONZI I'd no doubt start by lying to you – triple your money in months and such. QE started with a lie – it was to boost loans to the real economy and so on. I'm ex-cop and saw hundreds of scams as 'simple' as QE. A good one to look at now is the rip-off of US municipals – http://www.rollingstone.com/politics/news/the-scam-wall-street-learned-from-the-mafia-20120620
I generally found juries immune to fraudsters and their lawyers and this holds in the US municipals case. I think we need to 'go cop' to see that QE is really just a simple scam. As in the case Tabbi reports, we the public are the losers and a small few have been facilitated in looting. We need to boil it down to Cui Bono.
The banking system clearly could not be supported by different astrological positioning of money. In the Carrolo trial wiretaps clearly demonstrate the simple scam.
I guess QE somehow facilitates drawing fresh money in the Ponzi and the hiding of losses in an 888 account. The defense is that this is for the good of us all because otherwise the sky will fall. What we need to understand this is not the espoused theory of QE but the money trail and transaction transcripts of its theory-in-practice.
Our municipalities had plenty of well-qualified and well-paid lawyers and accountants, but were ripped off by a simple scam. The Fed and BoE have lots of well-qualified people too. QE will turn out to be a simple scam. We don't need complex explanations, but do need evidence of the transactions it has allowed. Anyone really want to bet on who is holding the debt parcel?
Matt YoungMatt Young
(Reuters) - JP Morgan chief executive Jamie Dimon is headed for a scheduled meeting, along with other bank executives, with President Barack Obama on Wednesday, the Wall Street Journal reported.
While talking to WSJ, an industry participant said concern over the debt ceiling battle would be raised during the meeting.
On the first day of shut down my true love gave to me
One JP Morgan CEOMatt Young
Wolf Richter: Bubble Trouble: Record Junk Bond Issuance, A Barrage Of IPOs, "Out Of Whack" Valuations, And Grim Earnings Growth
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.
When Blackstone's global head of private equity, Joseph Baratta, said Thursday night that "we" were "in the middle of an epic credit bubble," the likes of which he hadn't seen in his career, he knew whereof he spoke.
Junk bond issuance hit an all-time record of $47.6 billion in September, edging out the prior record, set in September last year, of $46.8 billion, according to S&P Capital IQ/LCD. Year to date, issuance amounted to $255 billion, blowing away last year's volume for this period of $243 billion. The year 2012, already in a bubble, set an all-time record with $346 billion. This year, if the Fed keeps the money flowing and forgets about that taper business, junk bond issuance will beat that record handily.
Junk-bond funds got clobbered in July and August as retail investors briefly opened their eyes and realized what they had on their hands and fled, and they went looking for yield elsewhere, but there was still no yield in reasonable places, and so they held their noses and picked up these reeking junk-bond funds again. Cash inflow doubled over the last week to $3.1 billion, the most in ten weeks.
Read more at http://www.nakedcapitalism.com/2013/10/wolf-richter-bubble-trouble-record-junk-bond-issuance-a-barrage-of-ipos-out-of-whack-valuations-and-grim-earnings-growth.html#ark1SZUXS2TjE6SW.99
I wonder if Dimon and Obama will notice that ginormous bubble in the market?Matt Young
U.S. stock-index futures advanced, signaling the Standard & Poor's 500 Index will rebound from a three-week low, as investors weighed the impact of the first partial government shutdown in 17 years.
Merck & Co. jumped 2.9 percent after the company announced an overhaul that will eliminate 8,500 workers. Under Armour Inc. increased 0.9 percent as JPMorgan Chase & Co. upgraded the maker of workout clothing. Symantec Corp. lost 2 percent after saying its chief financial officer left.
Shutdown? What shutdown?Fred C. Dobbs
Yesterday, ED.gov provided its annual update - this time to the 2010 three year and 2011 two year cohorts - and to nobody's major surprise, learned that things just got even worse. To wit: "The national two-year cohort default rate rose from 9.1 percent for FY 2010 to 10 percent for FY 2011. The three-year cohort default rate rose from 13.4 percent for FY 2009 to 14.7 percent for FY 2010." Putting this in context, according to Bloomberg defaults have risen to the highest level since 1995.
This is what has been driving JP Morgan out of the business for the past few months.
(True Believers are always Right.)
Conservatives With a Cause: 'We're Right' http://nyti.ms/15HBDIb
NYT - September 30, 2013 - ASHLEY PARKER
WASHINGTON - ... Senator Harry Reid, the Nevada Democrat and majority leader, had his own colorful, if somewhat skewed, metaphor about why much of the government was about to grind to halt in a take-no-political-prisoners fight over what is essentially a simple six-week funding bill, attributing it to the emergence of a "banana Republican mind-set."
Mr. Reid's language was evocative, and the implication was serious. With Democrats controlling the White House and Senate and with millions of dollars spent getting the health care law to the starting line, what gives House Republicans the idea that they can triumph in their push to repeal, or at least delay, the Affordable Care Act when so many veteran voices in their party see it as an unwinnable fight?
"Because we're right, simply because we're right," said Representative Steve King, Republican of Iowa, one of the most conservative of House lawmakers. "We can recover from a political squabble, but we can never recover from Obamacare."
Representative Raúl Labrador, Republican of Idaho and one of the original proponents of the so-called Defund Obamacare movement, was similarly sanguine. "We can always win," he said Monday afternoon, as he jogged up the stairs to a closed-door conference meeting, where House Republicans gathered to plot their next move.
Representative Pete Sessions, Republican of Texas and chairman of the House Rules Committee, hinted that Republicans were unlikely to give up without at least another round since they see their campaign against the health care law as something of a higher quest. And many, if not most, people they talk to - colleagues, friendly constituents, activists, members of advocacy groups - reinforce that opinion, bolstering their belief that they are on the right side not just ideologically, but morally as well.
"This isn't the end of the road, guys," Mr. Sessions said with a grin. "This is halftime." ...
Fund flows rebound
Fund flows rebounded significantly last week, reaching $1.4 billion versus $0.4 billion the week before. While this value is still below the huge $1.7 billion spike the week prior, it certainly shows that investors are still willing-at least for one last week-to speculate on bonds.
Nonetheless, as we've discussed, the statements by three Fed presidents are likely to dampen investor excitement.
August is usually a slow month, though this year, investors have pushed well into August, squeezing the last yield of the bond market (BND). The strong volumes from last week, though, may be the result of several issuers piling in before most of the dealmakers go on vacation.
If issuance volumes drop by the end of this week, the secondary market is likely to slow down as well. By the time the August vacation is over, the September tapering will be upon us. So right now may be a good time to hedge or get out.
Read on to see how the high yield bond market has behaved recently.
Continue to Part 4: Downside potential in September for high-yield bonds
But after August comes September, along with more tapering concerns, budget discussions, and debt ceiling hype. High yield bonds (HYG) are unlikely to move significantly higher in August, and September will only bring a wild ride of volatility with significant downside potential.
The high yield market (JNK) volume was extremely bullish last week, to say the leastThe fund flows for last week once again plummeted as investors remove cash from bonds ahead of the FOMC meeting.
Fund flows are key in determining the sentiment of investors towards a given asset class. Weekly fund flows measure how much cash investors put into and remove from mutual funds focused on investing in high yield bonds.
The $3.3 billion outflow last week follows an all-time high outflow of $4.6 billion the prior week. The year to date outflows are now $6.3 billion, after been positive just two weeks before. This strong reversal towards the negative side emphasizes how investors fled the asset class in anticipation of rising interest rates.
Investors averse to high duration
The fixed coupon of bonds makes them sensitive to changes in interest rates, causing the price of the bonds to fall as interest rates rise. Since the rise in interest rates is imminent, investors have been trying to off-load their exposure to bonds.
The upcoming Federal Open Market Committee (FOMC) will have Federal Reserve Chair Ben Bernanke issue a statement of their outlook on the economy and interest rates. If his message hints at an earlier than expected tapering of the expansionary monetary policy, then rates will go up. The Federal Reserve has been buying over $80 billion in long term Treasury and mortgage bonds, artificially increasing the demand and causing interest rates to fall. When these actions are removed, the rates will slingshot back up.
GETTING PERSONAL: Seeking a Less Rocky Road in Corporate Bonds
Jul 29, 2013 | ETRADE
(This article was originally published Friday.)
--Managers find investment-grade bonds attractive
--Some high-quality bond funds holding up better
--Despite risks, investors jump back into junkBy Murray Coleman
Yield-starved fund investors ready to move back into more risky corners of corporate bond markets might first want to pause and catch their breath, which is what many investment advisers are doing.
Instead of loading up on so-called high yield, or junk, they're taking advantage of greater opportunities in higher-rated issues.
Since a sharp sell-off in bonds from mid-May through late June, investment-grade corporates are looking more attractive by some valuation measures. With prices moving inversely to yields, such high-quality fare are also sporting more appealing income streams.
"We're finding investment-grade corporates to be a good place to hide out as bond markets search for some sort of equilibrium," says Lucas Turton, chief investment officer at Windham Capital Management in Boston with $1.2 billion in assets.
In mid-June, portfolio managers at the advisory firm started to slash holdings in junk exchange-traded funds. At the same time, they began adding to investment-grade corporate positions. A current favorite is the Vanguard Short-Term Corporate Bond ETF (VCSH).
With tapering of the Federal Reserve's massive bond-buying program and historically low interest rates still a concern, Mr. Turton says that "it just doesn't seem like a good time now to court more risk by moving too deeply into high-yield bonds."
While junk funds could be setting up for a stronger second-half, advisers point to several overhanging clouds.
"Although we expect better performance from high-yield bonds compared to investment-grade over the next several quarters, market volatility is also likely to be higher," says Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC.
The speculative U.S. bond market's default rate is on-pace to increase to 3.2% by November, Moody's Investors Service predicted earlier this week. That would be up from the second quarter's 2.9%, but still well below the 4.5% average since 1993.
"They're a more boring choice, but investment-grade corporates are standing on a little less scorched earth than high-yield bonds," says Daniele Donahoe, chief investment officer at Rinehart Wealth Management in Charlotte, N.C., with $300 million in assets.
Investors remain tentative about lower yielding parts of the corporate-bonds landscape, according to data from market researcher IndexUniverse. Since late June, net inflow into U.S. investment-grade corporate bond ETFs was at $203 million by mid-week, still far from replenishing a previous 30-day period of heavy losses.
At the same time, investors are returning to junk-bond funds in force. Since policy makers began reassuring markets about their economic stimulus plans, more than $2.9 billion has flowed into junk bond ETFs.
Investors are largely neglecting higher-quality bond funds, some of which are actually holding up better than their junk rivals, Ms. Donahoe says. One of her favorite picks is the iShares Intermediate Credit Bond ETF (CIU). While its returns dropped 3.57% from May 22 through June 25, the iShares 7-10 Year Treasury Bond ETF (IEF) lost 4.21%. Also, the iShares iBoxx High Yield Corporate Bond ETF (HYG) slumped by 4.59%.
"This sell-off was duration-based and investors need to be aware that big differences exist even within bond funds that are classified as intermediate-term," Ms. Donahoe says.
The biggest player in the field by assets, the $19.3 billion iShares iBoxx Investment Grade Corporate Bond ETF (LQD), has a weighted average maturity more than twice that of the iShares Credit Bond fund. It fell 6.07% in the pullback.
As long as defaults remain below long-term averages and a relatively low-rate environment persists, investors trying to live on fixed incomes should use all of the tools at their disposal, says Wes Moss, chief investment strategist at $1.1 billion Capital Investment Advisors in Atlanta.
His idea: Stick with investment-grade corporates at the longer-end of the intermediate curve like the iShares Investment Grade Corporate ETF. It has a distribution yield of 3.90%, more than the shorter-termed iShares Credit Bond ETF's 2.69%.
While higher credit quality corporates typically produce lower income streams, Mr. Moss says that many high-yield bond ETFs come with relatively low durations, which are measures of interest rate sensitivity.
The iShares High Yield ETF, for example, has a duration of 4.1 years with a yield of 6.45%.
"We're using high-yield bonds in combination with investment-grade securities to lower portfolio durations," Mr. Moss says. "It's really the best of both worlds. We're generating higher income and still keeping interest rate risks at bay."
(Murray Coleman is a wealth management columnist who writes about investing in exchange-traded funds and new trends in mutual funds. He can be reached at: firstname.lastname@example.org)
Subscribe to WSJ: http://online.wsj.com?mod=djnwires
Do Not Panic!! This is orderly...
The current decline in the high yield market, now at 30 trading days, has been the fastest since the end of the 2008 recession, with yields widening 159 bp. Only the July - October 2011 market decline had a greater ultimate magnitude than the current period.As we noted here:Panafrican Funk...
Remember - and it's important - there is no rotation that drives high-yield credit spreads wider without punishing equities. They are liabilities on the same capital structure and rise and fall in a highly correlated (well non-linear co-dependence) manner as the underlying business risk rises and falls.
Do not, repeat do not, see high yield credit weakness as a sign of rotation to stocks - if the credit cycle has turned then stocks are set to fall. And bear in mind that while HY yields are at all-time lows, spreads are not and in fact being short stocks relative to credit makes more sense if you are you are a bear on the credit cycle here.
The only problem being that the epic flows that sustained a credit market at non-economic levels for so long will exit in a hurry.nope-1004
Pretty good article showing the collapse of the stock div arb. Dividend stocks are going to get fucking pummeled.
Yes, there are occasionally people on the Fool that are not completely stupid.The big indicator prior to the 2008 market meltdown was the corporate bond market. Appears to be happening again, but will this time be different? Dunno.cougar_w
Please do not worry. 10 yr. creepin' to 2.61 currently.
In trading on Tuesday, shares of the High-Yield Municipal Index ETF (AMEX: HYD) entered into oversold territory, changing hands as low as $32.08 per share. We define oversold territory using the Relative Strength Index, or RSI, which is a technical analysis indicator used to measure momentum on a scale of zero to 100. A stock is considered to be oversold if the RSI reading falls below 30.
In the case of High-Yield Municipal Index, the RSI reading has hit 22.9 - by comparison, the RSI reading for the S&P 500 is currently 54.3.
A bullish investor could look at HYD's 22.9 reading as a sign that the recent heavy selling is in the process of exhausting itself, and begin to look for entry point opportunities on the buy side.
Looking at a chart of one year performance (below), HYD's low point in its 52 week range is $31.42 per share, with $33.57 as the 52 week high point - that compares with a last trade of $32.10. High-Yield Municipal Index shares are currently trading down about 2% on the day.
June 04, 2013 | Businessweek
Pacific Investment Management Co.'s Bill Gross, manager of the world's biggest bond fund (PTTRX), said the Federal Reserve's zero-bound interest rate policy and quantitative easing programs are becoming more of a problem for an economy that needs structural reforms.
The Fed's polices are "desperately attempting to cure an economy that requires structural as opposed to monetary solutions," Gross wrote in his monthly investment outlook posted on Newport Beach, California-based Pimco's website today. "Central banks -- including today's superquant Kuroda, leading the Bank of Japan -- seem to believe that higher and higher asset prices produced necessarily by more and more QE check writing will inevitably stimulate real economic growth via the spillover wealth effect."
The Fed is purchasing $85 billion a month in Treasuries and mortgage debt as part of its third round of quantitative easing, which began after it dropped its benchmark rate to almost zero to lift the economy out of recession. The central bank cut its target rate for overnight loans to a range of zero to 0.25 percent in December of 2008.
Haruhiko Kuroda, governor of the BOJ, is pursuing unprecedented stimulus to jolt Japan out of deflation. The European Central Bank cut its benchmark rate by 0.25 percentage point to a record 0.5 percent on May 2, and speculation has mounted that the Bank of England will increase its bond-buying target after Mark Carney takes over as governor next month.
The Fed holds more than $3 trillion in assets on its balance sheet as a result of three rounds of quantitative easing, up from about $900 billion in 2007.
"Low yields, low carry, future low expected returns have increasingly negative effects on the real economy," Gross wrote. "Credit expansion in the private economy is restricted by an expanding Fed balance sheet and the limits on Treasury" repurchase agreements.
Gross advised investors reduce risk and carry-related assets, referring to assets that have a higher perceived risk than securities such as Treasuries or longer-term debt.
Gross said May 16 that fixed income's three-decade bull market "was over." He said on May 31 that Pimco likes Treasuries (USGG10YR) that mature in five to 10 years, as there will be "no tapering for now."
Yields on 10-year Treasuries rose 46 basis points in May, including a jump of 16 basis points, or 0.16 percentage point, on May 28, as a report showing consumer confidence climbed to the highest in more than five years bolstered speculation the Fed would scale back its purchases. Gross's Pimco Total Return Fund (PTTRX), the world's largest mutual fund, declined 1.9 percent in May, the biggest monthly loss since September 2008.
The performance (PTTRX) of the $293 billion Total Return Fund puts it behind 94 percent of similarly managed funds through May 30, according to data compiled by Bloomberg. The fund's allocation to Treasuries has hindered performance as government-debt securities declined.
U.S. government debt tumbled 2 percent last month, the most since December 2009, according to Bank of America Merrill Lynch indexes. Employment gains and increases in housing and consumer confidence suggested the recovery in the U.S. economy, the world's largest, is gaining momentum.
Global bond markets posted their biggest monthly losses in nine years in May. The Bank of America Merrill Lynch Global Broad Market Index, which tracks more than $40 trillion of bonds, fell 1.5 percent.
Gross raised the holdings of Treasuries in his flagship fund to 39 percent as of April 30, the highest level since July 2010, from 33 percent as of March 31. He's increased the proportion of U.S. government securities every month this year since February. In 2011, Gross's fund lost an estimated $5 billion to withdrawals, according to Morningstar Inc., after he eliminated U.S. Treasuries early in the year and missed a rally.
Pimco, a unit of the Munich-based insurer Allianz SE, managed $2.04 trillion in assets as of March 31.
To contact the reporters on this story: Liz Capo McCormick in New York at email@example.com
To contact the editors responsible for this story: Dave Liedtka at firstname.lastname@example.org
Junk bond issuance is at record highs this year-and thus at the greatest danger should yields start rising.
Companies around the world have issued $254 billion in high-yield debt this year, a number that includes $130.6 billion from the U.S., according to the latest numbers from Dealogic.
Global issuance is up a stunning 53 percent from the same period in 2012 and has accounted for 9 percent of the total deals in the debt capital markets space-also a record and fully one-third higher than last year's pace.
The U.S. issuance has increased 24 percent over the previous year. Record issuance also has come from the U.K., China, Russia-and debt-plagued Italy, which despite being at the center of the European sovereign debt crisis has seen $7 billion hit the junk bond market this year, Dealogic said.
Because junk bonds have a history of trading in tandem with the stock market , it's not a big surprise to see issuance swell.
The Standard & Poor's 500 (^GSPC) has surged nearly 16 percent this year, and the high-yield market has followed. The Barclays U.S. Corporate High Yield Index returned 4.75 percent through April.
But with investors beginning to fear that the Federal Reserve may stage an early exit from its monetary stimulus programs, fears are growing that junk bonds could take a hit.
"On the surface, things look pretty good in the high yield market," Citigroup analysts said in a report. "Digging a little deeper, however, we see some troubling signs."
All that supply is beginning to take a toll on the secondary market-where those who buy the bonds from issuers go to trade them-and there are signs that demand is waning.
The two leading exchange-traded funds for junk-the SPDR Barclays High Yield Bond (JNK) and the iShares iBoxx $ High-Yield Corporate Bond (HYG)-sustained a combined $660 million in outflows last week, the second-worst of any class after emerging markets, according to IndexUniverse.
Mutual funds saw a similar trend, with $581 million in high-yield redemptions, the worst week since November, according to Thomson Reuters.
Citi said the monthly total looks like it will be the largest high-yield selling since at least November 2008.
Where the market goes from here is likely dependent on the Fed.
Some Open Market Committee members indicated at the last meeting that a gradual decrease of the central bank's $85 billion a month in purchases of Treasurys and mortgage-backed securities would be warranted as early as June.
In response, Treasury yields have jumped upwards, and some firms-Goldman Sachs, in particular-are asserting that these could be the early days of the bond bull market's demise.
"We've been bullish on high yield since September and will not change our view based on these developments, because we believe the market has overreacted to the Fed's comments," Citi said. "They highlight, however, the challenge for the FOMC and the risk of a policy misstep."
The biggest potential misstep: A move by the Fed that would startle markets, push investors away from riskier bonds and send yield spreads wider.
All that issuance suddenly would find a tougher marketplace, driving up yields and making borrowing for lower-credit companies significantly more expensive from the current yields which slipped below 5 percent in May.
Citi said the exodus from high-yield has been due to "an expectation of faster liquidity withdrawal from the Fed" and warned that "as this occurs, capital flows are likely to turn negative, in our view, thereby limiting access to funding and maybe even increasing default concerns."
As evidence mounts that a mid-year slowdown is taking place in the world economy, the next few days will offer a clearer glimpse of how that will impinge on policymaking and buoyant financial markets.
... ... ...
Some poor business surveys from China have also had an impact, suggesting the world's No.2 economy is struggling for momentum.
... ... ...
"The underlying momentum in the global economy is weaker than it should be at this point of the economic cycle, five years after the global crisis," said Lena Komileva, director of G+ Economics consultancy in London.
"We have yet to see evidence of a convincing, self-sustained positive feedback loop between real growth and market value inflation."
... ... ...
Growth is still proving to be elusive for the euro zone economy, largely thanks to the extent of the budget austerity taking place across the continent.
... ... ...
March 5, 2013 | Barrons.com
Pimco's Bill Gross was on Bloomberg TV today, where he was asked whether junk-bonds – currently yielding 5.81% on average at a spread of 4.98 percentage points over Treasuries – continue to make sense if risk premiums fall further given the market's inherent risk. Here's Gross:
Are [spreads] less rational at 4 or 3 [percentage points]? Certainly. We know, and history would prove that in the high-yield market that as the exuberance follows through, that defaults begin to increase. That's one of the pieces of the puzzle that Jeremy Stein, the Fed governor, pointed out in his paper where he spoke to irrational exuberance. So defaults are coming, it's just a question of how extensive they are. And if they're only at a 2-3% pace, which is where they are now, and if you get a normal recovery, then you're still left with a 3-4% return at today's levels. If you squeeze it a little bit more, then you're getting closer to that cash [return] number, that is really a point of little return.
... We could think of that as the yield on fixed-interest investments which compete with equities, or - more realistically - as the borrowing cost to buy corporate cash flows.
That has come down to the lowest level in history, thanks to the Federal Reserve. It costs junk-rated single-B borrowers only 6% on average to issue new 10-year debt. It's hard to compare the yield on single-B securities with prospective earning s on stocks. Single-B borrowers are likely to default. The time value of money argument becomes confusing because the future default rate is unknown.
But if you are a private equity fund buying a traded company, as Brazil's 3G Capital and Warren Buffett bought Heinz last week, the likelihood of default has a totally different meaning: that's the likelihood that you will default to people who lent money to you. As much as it hurts to default, it hurts a lot more to be on the receiving end of a default. As one industry giant told me years ago: "High yield bonds are there to be sold, not bought."
Exhibit 5: Junk bonds at lowest yields on record
Why are junk bond yields at all-time lows? There are two big reasons. The first is that the economy has been more cartelized, less entrepreneurial and less risky. The bad news is always someone's good news. During the 1990s, disruptive new technologies turned a lot of stable franchises to junk - literally, in the case of some telephone company bonds. The Facebook misfire and Apple's fall from grace point up the sclerotic character of the economy. No-one need worry about entrepreneurial challengers. They have nothing to do with the price of ketchup.
And the second is that the Federal Reserve has vacuumed up a vast amount of risk into its own portfolio (by purchasing longer-term Treasuries and mortgage-backed securities), leaving the market chronically short of yield.
Private equity firms can borrow at the lowest yields on record and lever up the earnings of stable corporations like Heinz, extracting the difference between the cost of financing and the levered earnings yield. That makes the equity of predictable companies like Heinz valuable.
Early last month, Fed Governor Jeremy Stein gave a speech titled Overheating in Credit Markets: Origins, Measurement, and Policy Responses that raised the question of whether or not we might be seeing a bubble, and if so what might be done about it.
You've probably heard a lot of talk about the aggressive lengths that money managers are going to to "reach for yield" in the context of this ultra low-rates environment.
Stein didn't sound too fearful yet, but the overall concern is that we could be setting up another credit bubble, just like before the recent crash.
In the latest version of their US Interest Rates Strategist letter, Morgan Stanley's Vincent Reinhart and Matthew Hornbach look at the scene in corporate credit and determine that the market might be "modestly rich" rather than straight-up "overheated."
Three charts from their work stand out, that nicely call into question the idea of a bubble.
First, although junk bond (or high-yield) yields are at record lows, actual spreads (where those yields are relative to risk-free Treasuries) remain well off their lowest levels.
The chart is a little bit noisy for the unfamiliar, but the line to watch here is the green line, which shows the average high-yield spread, or the average difference between what high-yield credit pays and what risk-free Treasuries pay. The current difference is about 500 basis points, well above the less then 300 basis points that we saw pre-crisis.
The next chart shows what companies are doing with the proceeds of their high-yield borrowing. Whereas in 2007, high-yield debt issuance was going to things like leveraged buyouts and other acquisitions, these days the proceeds are going overwhelmingly to refinance old debt, which is just really prudent financial management.
And then finally, the underlying condition of high-yield debt issuers is in better shape these days. They have more cash relative to debt, suggesting that their credits are fundamentally safer.
None of this is to suggest that there aren't causes for concern. And you should read Jeremy Stein's speech (here) but the evidence of a raging bubble in this space has to be tempered by signs that prices aren't totally out of whack, and issuers of high-yield debt aren't going crazy.
February 27, 2013 | WSJ.com
"On a scale of 1-10 measuring asset price 'irrationality', we are probably at a 6 and moving in an upward direction," Gross writes in his March investment outlook. "Corporate credit and high yield bonds are somewhat exuberantly and irrationally priced. Spreads are tight, corporate profit margins are at record peaks with room to fall, and the economy is still fragile."
But Mr. Gross doesn't recommend selling en masse, only lowering return expectations. After double-digit returns on junk bonds last year, he says 3%-to-4% returns are more likely this year. Prices are too high and yields are simply too low for the market to continue delivering such high returns.
Mr. Gross-often dubbed "the Bond King"-spends much of his March outlook referring back to a Feb. 7 speech from Federal Reserve governor Jeremy Stein, who expressed concern that "we are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit."
For Mr. Gross, those comments harked back to the famous "irrational exuberance" talk in 1996 from former Fed chief Alan Greenspan. Now, as then, the market is trying to determine whether certain assets are overvalued and what to do about it.
His conclusion: be cautious.
"We join with Governor Stein and perhaps Alan Greenspan in encouraging not an exit but a reduced expectation," he says. "Be rational, be optimistic if so inclined, but temper it with a commonsensical conclusion that we have seen something similar to this before, and that previous outcomes seldom matched the exuberance."
Mr. Gross's comments come a day after Fed chairman Ben Bernanke weighed in on the question of overheated markets in his speech to Congress on Tuesday. "Although a long period of low rates could encourage excessive risk-taking … we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation," the chairman said.
The value of 200 days average is 5.99 or $.09 below the value on Feb 11 closing. 1000 days average is 5.58.
At the beginning of 2004 (also four years from previous recession, junk dropped from 6.40 to 6.15. After then it went downhill to 3.90 in December 2008.
Binyamin Appelbaum:Fed Official Sees Tension in Some Credit Markets, by Binyamin Appelbaum, NY Times: Some credit markets are showing signs of overheating as investors take larger risks in response to the persistence of low interest rates... Fed Governor Jeremy Stein, highlighted a surge in junk bond issues, the popularity of certain kinds of real estate investment trusts and shifts in bank balance sheets as areas the central bank is watching closely...Mr. Stein gave no indication that the Fed is contemplating any change in its aggressive efforts to hold down interest rates. Rather, he described the overheating as a trend that might require a response if it intensified over the next 18 months. But the speech nonetheless underscored that the Fed increasingly regards bubbles, rather than inflation, as the most likely negative consequence of its efforts to reduce unemployment by stimulating growth. ...Central bankers historically have been skeptical that asset bubbles can be identified or prevented from popping. Moreover, they tend to regard financial regulation as the appropriate means to prevent excessive speculation and not changes in monetary policy ... But the crisis has forced central bankers to reconsider both the importance of financial stability and the role of monetary policy. ...And he closed on a cautionary note. "Decisions will inevitably have to be made in an environment of significant uncertainty," he said. "Waiting for decisive proof of market overheating may amount to an implicit policy of inaction on this dimension."
With fiscal policy moving in the wrong direction -- deficit reduction rather than employment enhancing stimulus, e.g. infrastructure -- if monetary policymakers begin getting skittish, then the unemployed will lose the one institution that seemed to actually care about their struggles. Not good.
Jan 28, 2013 | Forbes
Junk bonds: talk about an awful description for non-investment grade debt. And we all thought B's an high C's in school were above average.
In some cases, they are.
The ugly junk bonds of old have now become the more palatable high yield bonds of today. In a low interest rate environment like we have now, high yield is a Godsend. These companies are high yield for a reason, of course. Their debt is riskier. Credit analysts look at the corporate balance and income sheets and gauge whether or not a company has enough money to cover its short term maturing debt while paying interest on its long term loans, and still manage to grow as a company. Those who can barely cover it are always considered high yield.
Yet, high yield issuers are doing pretty good as an investment class.
In fact, for the third year in a row the default rate for non-investment grade bonds stood at 1.9 percent, Fitch Ratings said Monday in a special report. That's higher than the 1.5 percent default rate last year, but still well below the historic average default rate of 4.9 percent.
Thirty-two issuers defaulted on $20.5 billion in bonds last year, compared with 29 issuers and $15.9 billion in 2011. The year produced a considerable number of large defaults, though, including bankrupt firms like Edison Mission Energy ($3.7 billion), Residential Capital ($2.8 billion), ATP Oil and Gas ($1.5 billion) and struggling names like Energy Future Holdings ($1.8 billion), also on the cusp of Chapter 11.
Fitch Ratings projected that the default rate in 2013 will be similar to last year's. If Energy Future Holdings goes under, then it could push the rate up higher due to the company's size. Plus, with the U.S. economy still running on easy money, the constructive outlook for defaults is heavily dependent on steady, if not, stellar macro conditions, today's report stated. Fitch is projecting U.S. GDP growth of 2.3 percent in 2013, assuming political discord in Washington does not have a material impact on the economy.
Fitch believes that the default rate on high yield debt would "at least double if the economy slides back into recession or very low growth."
Junk bond funds have been relatively quiet this year. State Street's $40 billion Barclays High Yield Bond (JNK) exchange traded fund is up 1.58 percent year-to-date ending, while the S&P 500 is up 5.3 percent. By comparison, JNK is beating the Barclays 3-7 Year Treasury Bond Fund (IEI), which is down 0.5 percent year-to-date. Over the past 12 months, the JNK bond ETF rose 4.79 percent to IEI's 0.4 percent "low yield/risk-free" gain.
Last year's riskiest sectors were the paper and pulp industry (7.7% default rate), utilities (10.5%), consumer products (4.7%), transportation (4.4%) and banks (3.3%).
High yield issuance topped $300 billion in 2012. The majority of that was used to refinance existing debt and by the end of 2012, 80 percent of market volume ($1.13 trillion) consisted of bonds sold since 2009. Beyond pushing out debt maturities last year, high yield borrowers in 2012 saw a decline in their interest rates as demand for their bonds rose. Higher demand for bonds, means higher bond prices. Higher bond prices, of course, means lower interest rates for the one's issuing the debt. The weighted average interest rate offered slipped to 7.99 percent from a higher yielding 8.27 percent at the beginning of 2012. As a result, issuance began to move more aggressively down the rating scale as companies felt they had a better chance to find a lender at lower cost. From July to year-end, the volume of 'CCC' rated new bond issues rose 54 percent and made up 18 percent of overall junk bond issuance.
The Junk in JNKs Trunk
Company Sector Coupon*
HCA Holdings Healthcare services 6.5%
Sprint Nextel Telecommunications 9.0%
First Data Business services 12.62%
Energy Future Utilities 10%
Samson Investment Co. Energy 9.75%
Community Health Sys Healthcare services 8.0%
Ally Financial Banking 8.3%
FMG Resources Metals & mining 7.0%
Everest Acquisition Oil & gas 9.37%
Dish DBS Broadcasting services 6.75%
*Coupon, for the non-bond lords among us, is the yield offered at issuance. Current yield almost always differs from the coupon rate as bond prices fluctuate.
Jan 26, 2013 | Forbes
Earlier this month, the yield on the average junk bond dropped below 6% for the first time ever. Because of this, many investors think that yields can't go any lower and that interest rates will reverse in 2013.
Here's four reasons why they are wrong:
Reason number 1: Junk bond credit spreads are not anywhere near all time historical lows.
In addition to the interest rate a particular type of bond (ie. high yield, investment grade etc) is paying, bond traders will look at how that rate compares to treasuries. This comparison enables traders to understand if a category of bonds is expensive or cheap given the current level of overall interest rates.
The below chart shows the difference in yield between the average high yield bond, and a treasury of the same maturity. This is what is known as the high yield credit spread. (You can learn more about credit spreads here.)
As you can see from the above chart, while junk bond yields are at all time lows, the high yield credit spread is nowhere near an all time low. In fact, there were two extended periods of time since 1996 (which is as far back as the Fed's data goes), that the high yield credit spread was around 2.5%. This means at its current level of 5%, the high yield credit spread would have to drop another 2.5% before hitting a new all time low.
Reason Number 2: Corporate Default Rates are near an all time low
As you can see from the below chart, the average default rate on corporate bonds is around 4%. That compares to the current default rate of around 1.1%. So, while junk bond yields are at historic lows, so is the corporate default rate.
Reason number 3: Yield starved bond managers are going to start to leverage up.
This one I got from a recent presentation by bond guru Jeffrey Gundlach. In his view the Junk bond market is not yet in a bubble. Normally, a bubble is partially caused by investors increasing their leverage, which has not yet happened. He does think however that bond managers are going to start adding leverage to try and juice whatever yield they can out of this low yield environment.
When this happens it will have the same effect as if a lot of new money and demand was coming into the market. While this will likely inflate a junk bond bubble in the future, it is likely to send yields even lower in the near term. A recent article in the Wall Street Journal confirms that this is already starting.
Reason number 4: Everyone thinks there is a bubble in junk bonds.
Learn Bonds publishes a piece called The Best of the Bond Market, where we link to all the best bond market stories from around the web each trading day. There have been so many stories about the "bubble in junk bonds" that I have had to tell the writer to start leaving some of them out. If we included them all then half the stories in the piece would be the same story calling for a bubble in junk bonds.
From my experience when everyone thinks a market is going to go in one direction, that market has a nasty habit of heading in the exact opposite direction.
For another idea on how to increase yields in this low yield environment read our article Dividend Investing for Bond Investors here.
When you invest in risk, you want the reward, right? Yet, emerging market and high yield bonds in general have underperformed safety all year. The trend, says David Sherman, manager of the RiverPark Short Term High Yield (RPHYX) bond fund could be drawing to a close.
"Although the high yield market sentiment often is correlated to the equity market, the space has gotten very beaten up. Unless Europe and the U.S. address their balance sheets and provide world leadership to rebuild confidence, I suspect high yield will outperform equities over the next 12 months," Sherman says.
"Investors can earn a yield-to-maturity on an average duration of around 3 years in high yield in excess of 12% on a diversified portfolio rated B/B- with Debt/EBITDA of under 4.5 times," he says.
The Merrill Lynch High Yield Master II Bond Index ended the third quarter down 1.69%, the worst quarterly performance since the third quarter of 2008 and the fourth worst performing quarter since September 1986.
The risk trade had investors pouring into Treasury bonds. Outflows of high yield bonds and ETF funds totaled $10.4 billion in August and September, roughly 0.34% of the market's actual size, according to Lipper.
As a result of the sell-off in the quarter, Sherman thinks high yield is now undervalued given the current low interest rate environment. Plus, a weak outlook in the U.S. and Europe, coupled with slower growth in China, means the global economy will likely "muddle through" the next 12 months, making high yield bonds a defensive investment class with equity like upside, Sherman says. In a worst case scenario, such as a double dip recession, high yield would get clobbered.
High yield bond spreads soared in 2008 by more than 400% to more than 700 basis points over Treasurys before declining in 2009. Spreads over Treasurys is now around 170% of the TSY yields. Last month, average interest rates on high yielding corporate debt stood at 8.84% compared to 1.9% for 10 year TSYs.
"I don't like Treasurys, but that doesn't mean U.S. government bond prices will continue to retreat," he says. Ten year bond prices have fallen below par after trading well into the 120s for all of September.
"It is hard to fight the Fed and herd behavior. We had a pretty significant short on 10 year Treasurys, which we ultimately threw in the towel. I shorted the Treasury yield thinking lack of political leadership from Washington, the U.S. debt ceiling, and the general continued deterioration of the U.S. balance sheet would demand a higher real interest rate by lenders. I was surprised that after S&P downgrade, the UST rallied," he said.
Bank of America bonds. While an advocate of high yield corporate debt, Sherman warns investors away from Bank of America bonds yielding over 5%. "I wouldn't touch them just from a fundamental risk versus reward perspective," he says.
"Bank of America takes credit, trading, and operating risk every day and employs significant leverage. Any tiny mistake is magnified. I don't like the idea of being at the bottom of the capital structure since depositors are senior to me in which I make limited upside but the downside is horrible. Maybe an interesting stock investment because you enjoy the spoils of success with similar downside risks as bondholders. But as a bondholder with a capped upside on a financial institution business model, 'no thank you'."
See: For Fixed Income Investors, Another Way To Beat Treasurys
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