The Great Crash of 2018? Look to the bond markets to trigger
Mayhem!
I had the impression the markets had pretty much battened down for
rest of 2017 – keen to protect this year’s gains. Wrong again. It seems there
is another up-step. After the People’s Bank of China dropped $47 bln of money
into its financial system (where bond yields have risen dramatically amid
growing signs of wobble), the game’s afoot once more. The result is global
stocks bound upwards. Again. It suggest Central Banks have little to worry
about in 2018 – if markets get fraxious, just bung a load of money at them.
Personally, I’m not convinced how the tau of monetary market
distortion is a good thing? Markets have become like Pavlov’s dog: ring the
easy money bell, and markets salivate to the upside.
Of course, stock markets don’t
matter.
The truth is in bond markets.
And that’s where I’m looking for the dam to break. The great crash of 2018 is
going to start in the deeper, darker depths of the Credit Market.
I’ve already expressed my doubts about the long-term stability of
certain sectors – like how covenants have been compromised in high-yield even
as spreads have compressed to record tights over Treasuries, about busted
European regions trying to pass themselves off as Sovereign States (no I don’t
mean the Catalans, I mean Italy!), and how the bond market became increasingly
less discerning on risk in its insatiable hunt for yield. Chuck all of these in
a mixing bowl and the result is a massive Kerrang as the gears of finance
explode!
Well.. maybe..
I’m convinced bond markets are
the REAL bubble we should be watching.
I’m convinced it’s going to
start in High Yield.. so let’s start by talking about Collateralised Loan
Obligations – the CLO market. Did you know that since the
Global Financial Crisis (GFC) in 2008 only 20 out of 1392 deals have seen their
riskiest tranches default? (I pinched the numbers from a Bloomberg article.)
When I quoted these numbers in the office everyone was surprised.. Surely
losses were greater?
Of course not.
It wasn’t just banks that benefitted from Too-Big-To-Fail. (TBTF)
Most CLOs did very well. In 2008 smart credit funds realised they would benefit
on the back of TBTF and did exceeding well out buying cheap CLOs from panicked
sellers. As the GFC unfolded in the wake of Lehman’s default, the global
financial authorities pulled out the stops to stop contagion. Banks were
unwilling to realise further losses, interest rates plummeted, meaning the
highly levered companies issuing the debt backing CLOs survived and were better
able to repay their existing debt.
The 2008 GFC was about consumer
debt – triggered by mortgages. We still have consumer
debt crisis problems ahead (in credit cards, autos and student loans). There is
also the fact Consumers have suffered most these past 10-yrs as massive income
inequality has left them paid less and paying more for everything – which is
most definitely going to come back and haunt markets at some point.
But, I do think the next Financial Crisis is likely to be in
Corporate debt, and will be an credit market analogue to the consumer debt
crisis of 2008. The Hi-yield market is the likely source - as markets recovered
banks started lending again, and low rates forced investors out the credit-risk
curve to buy returns. The funds who used to buy nothing but AAAs are now buying
speculative single B names. Such is the demand for assets, these companies have
been able to lever up and refinance, increase leverage and refinance further,
at ever faster rates.
It’s been exacerbated by private
equity fuelling returns through debt. As demand has increased
exponentially, borrowers have been able to slash Covenants, making it easier
and simpler for over-indebted companies to raise more and more dosh.
Where does it end?
As rates rise we’re going to see the “Toys’R’us” moment repeated
on a grand scale. The rise of and fall of Zombie companies that simply can’t
meet debt payments is bound to contage not just the rest of the credit market,
but also stocks.
More immediately, the realisation a crisis is coming feels very
similar to June 2007 when the first mortgage backed funds in the US started to
wobble. (The first few pebbles rolling down the hill before the landslide?) It
explains why we’re seeing the highly levered sector of the Junk bond markets
struggle, and companies correlated to struggling highly levered consumers (such
as health and telecoms) also in trouble.
Basically, the very little is really fixed since the 2008
financial crisis. 10-years later, here we are with the next bubble about to
burst. Corporate debt watch out.
Which leads us to the UK Housing Sector…
A few days I commented on how UK house prices have risen 50% over
the last 5-years – a period which has seen incomes stagnate. The result is its
practically impossible for anyone on a normal salary to even contemplate ever
affording their own house – a very good article in the FT yesterday saw the
author explain he’d have to save 20% of his gross income for 60 years to be
able to put down a deposit on the bed-sit he lives in!
In short, the great myth of the Thatcher generation is dead. The
dream of home ownership in the UK won’t happen for our children’s generation..
They will be forced to rent, and that’s a very expensive market here in London.
At the moment a mortgage is far cheaper than renting – but as rates rise that
will correct a little.
Somehow we have to create decent rental accommodation at a cost
comparable or below mortgages. After all, if you own a house you save money on
accommodation, and you get all the upside from appreciation of the asset.
Historically, housing has been a better performing asset to own than even
stocks - so perhaps there is even a tax angle there, but one no sane politician
would date to broach.
To make it happen we need to encourage public and private
landlords with the where-with-all to build new quality rentals - and
surprisingly this may be possible under current government polices announced
yesterday such as privatising the Housing Associations. As this point regular
readers will be in shock – “Blain praising the government? Pass the smelling
salts”!
Insurance and pension funds will fund the assets - they know house
are literally "safe as houses"! There is a clear role for
Housing Associations to become even more important quality providers of rental/social
accommodation.
The big risk is some political fool will decide to enhance their
electoral prospects with some ill-conceived "right-to-buy" policy
which will simply fuel expectations, drive up consumer borrowing, and fuel a
boom market once more putting property out of reach for the masses.
Meanwhile, I suppose we should be worrying about the fact Merkel
still can’t put a government together, the fact it’s now pay to get out of jail
in Saudi, and all the other noise. Will anyone be listening to Theresa Maybe in
Brussels today?
http://www.zerohedge.com/news/2017-11-17/bill-blain-stock-markets-dont-matter-great-crash-2018-will-start-bond-market
