Ten years after the Global Financial Crisis, and we are still dealing with the same stress in the system and the risk of it being unwound, debt and credit. Human beings are supposed to be evolutionary creatures, yet we are driven more by greed and opportunity than any innate desire to help or nurture, survival instincts kick in, kill or be killed law rules the land. Trading floors are no different than the arenas that host gladiator games, in this case one that is most liquid survives.
Credit markets are set for the worst year since GFC in 2008. If one were to go through the string of blow-ups, (Vallourec SA (VLOWY) notes, Nyrstar (NYRSY) , GE (GE) to name a few), it is totally understandable why investors are jittery. To put it simply, given the free money circulated by global central banks, corporations have been raising debt (corporate leverage), but not using it to raise productivity or buy new assets, instead give it back to shareholders via buybacks and dividends. The whole reason to raise debt was to grow the business to be able to produce more cash to pay down their debt. Now as dollar debt servicing costs rise, these companies are cash strapped. Seems Emerging Market economies and these corporations have the same thing in common: they are debt addicts.
Corporate bonds have fallen across the board. Investment Grade Dollar bonds are down 3.71% in 2018, with Sterling ones down 2.9%, and even Euro High Yield is down 1.2%. Credit default spreads tied to European high yield corporate bonds are also faring the worst since 2011. The market iTraxx Europe Crossover index is widening for a ninth day in a row, and people wonder why Equities are being sold down relentlessly every day? When this gauge widens, it means there is stress in the system. The worry is that it starts from a few company specific issues, namely GE and PG&E (PCG) , but as their debts get downgraded to junk status, investors in high yield bonds need to reallocate their portfolios and sell down other names. This can cause a domino effect if it is done in a very short period of time. Throw in a much tighter financial conditions environment, mixed with deleveraging, and one can get a pretty toxic cocktail of a blow-out.
2018 has been a year of all asset class blow ups. First volatility (VIX), then Chinese Base Metals (Copper), followed by Technology (FAANG), then darling Oil Markets, and now Investment Grade bonds. This week we had a new casualty, or rather a reset from last year, Cryptocurrencies as Bitcoin and their brethren got FUBAR'd. That is what 10 years of leverage does when unwound in just a matter of a few months. Everything is built on a house of cards and one small piece removed incorrectly and the whole structure can crumble faster than the player can actually say the name "Jenga".
The billion dollar question now is, what will the Fed do? The market pleaded several times over the summer for them to stop raising rates. Trump even claimed "Fed has gone crazy", whereas in fact he should be looking at a mirror whilst saying that. The Fed in all honesty did not have much data to warrant stopping raising rates. Investors are like petulant children. To put it in perspective, we have not even breached the lows of the market ( (SPY) ) witnessed in April 2018! However, now with inflation clearly not an issue as Oil prices have fallen 30% from their highs, which will show up in CPI data in the next few months, perhaps the Fed can ease up a little now.
The December FOMC meeting held on 18th December is pricing in about less than 70% probability of a Fed rate hike, down from greater than 80%. In all likelihood, it will go through but there is a chance that the commentary may be firmly dovish. Either that or the markets will fall to a level to force the Fed's hand. Until then, we can fall a lot more than investors think as algorithms are taking over sending sharp sell signals to their masters causing the relentless selling we are witnessing right now. No human emotions, just signals!
As the old adage goes, "the market can be irrational a lot longer than one be liquid".
All eyes on the Fed now. Well played Trump. Rock the boat, throw away the anchor, and point the finger at the Fed.
