Bounces, Bubbles, Spreads, Deficits and A Bad Moon Rising
Johnny Nash... "I can see clearly now the rain is gone."
Last week: Crude jumping from $57 to $62 on Iran fears...The 10 yr note fell to its lowest level in a month as rate cut expectations fell on inflation fears... as interest rates went up the dollar strengthened vs Yen & Euro...
Asian stocks with their 1st weekly gain since the 02/27 rout... European stocks with their biggest weekly gains in 4 years on M&A activity... US Stocks with their largest weekly gains since 2003...
We're almost out of the woods, right?? Wrong, DEAD wrong... Just when you thought it was safe to go back in the water, you can't even make it past the sand....
The Nattering One believes that there is something nasty still lurking in the woodshed... and so does MSN Money's Jim Jubak... JJ explains Why the debt bubble hasn't burst - YET. Some key excerpts (with our Nattering in italics)...
...we equity investors can just go back to our usual worries about slowing economic growth and whether the Federal Reserve will cut interest rates, right? Absolutely wrong. At least in the long run.
We're in the midst of an already huge bubble in the debt markets that's going to get bigger before it finally deflates.
That bubble is characterized by huge bets on risk in the markets for government notes, corporate bonds, home mortgages and the various synthetic derivatives based on those instruments.
The Nattering One has commented many a time on the CDO & MBS derivatives problem... And it's likely to take years to deflate -- either gently or in one big pop.
Like all pension funds and insurance companies, the New Jersey state pension fund wants to match the maturity of the financial instruments it buys to the year when those liabilities come due.
Multiply New Jersey's problem by the tens of thousands of state, local, national and corporate pension funds around the world all facing skyrocketing future liabilities...
...then add in insurance companies and other institutional investors also looking to generate cash flow to meet the demands of aging investors,
and you'll get global bidding for debt instruments with the highest possible projected returns and acceptably low projected risk.
The Nattering One has already commented on our huge and constantly growing Pension Funding Deficit Disorder, public (social security, state and local municipalities ) and private sector alike....
The more money there is in search of higher yields, the higher those buyers will drive prices for high-yielding debt securities, and the lower those yields will fall.
The only way to make up for falling yields, of course, is to take on more risk. The trend toward less yield for higher risk has been in place pretty much without interruption since the third quarter of 2001
Recently as defaults in subprime have occured yields on riskier collateralized debt obligations built around pools of subprime mortgages have climbed to 6.25% over the benchmark London Interbank Offer Rate (LIBOR).
At the end of 2006, according to Credit Suisse, the spread was just 3.5% over LIBOR. This recent narrowing of margin spread has raised yields and lowered the prices of the debt instruments.
The Nattering One has already commented on the narrowing of these margin spreads, and thus higher risk environment typified by a recent uncharacteristic lack of defaults in these high risk debt instruments...
Default rates among the issuers of corporate junk bonds, (high-yield, high-risk debt), peaked at close to 12% at the end of 2001 and have declined ever since to stand at just 1.6% in February 2007...
The average for the past 25 years is a default rate of 4.7%. From 2001 on, rates and return have been low while prices and risk have gone higher. The recent unwind and narrowing of spreads is the first round in a debt market deflation.
These investors will play the game until it comes crashing down around them, because they don't have a viable alternative other than investing billions in cash they don't have in underfunded pension plans.
As long as economic growth looks halfway decent, these investors will hang on, no matter how deep their doubts and worries.
If these investors, with their exposure to high yield and long maturity debt, can just hold out until the Federal Reserve cuts interest rates, they'll make a killing. The prices of risky, high-yield, long maturity debt soar when interest rates decline.
Five things to contemplate: 1. The debt bubble is much larger than subprime. 2. The possibility of Fed lowering will put a temporary floor in the debt market, delaying the debt market deflation.
3. The debt bubble will burst with an economic downturn. 4. Expect more episodes similiar to the last few weeks as "trapped" debt market participants attempt to unwind their positions.
5. The Baby Boomer crisis that is about to sweep Euro-peon and US markets in the next few years.
In the U.S. alone, 77 million baby boomers are on the verge of retiring. This will wreak havoc on Social Security, private pension systems and the health care system.
To pay for these benefits, a massive equity sell off and in particular debt liquidation will have to occur over several years. This sell off could create a long term market decline in the U.S.
Of course, if the Fed does lower, which they will have to by the end of summer, the long term high yield debt already held would go up in value and could well finance part of the pension deficits.
That is if the derivative based MBS backed CDO's don't implode by then.... CCR... "I see the bad moon a-risin'. I see trouble on the way."
Last week: Crude jumping from $57 to $62 on Iran fears...The 10 yr note fell to its lowest level in a month as rate cut expectations fell on inflation fears... as interest rates went up the dollar strengthened vs Yen & Euro...
Asian stocks with their 1st weekly gain since the 02/27 rout... European stocks with their biggest weekly gains in 4 years on M&A activity... US Stocks with their largest weekly gains since 2003...
We're almost out of the woods, right?? Wrong, DEAD wrong... Just when you thought it was safe to go back in the water, you can't even make it past the sand....
The Nattering One believes that there is something nasty still lurking in the woodshed... and so does MSN Money's Jim Jubak... JJ explains Why the debt bubble hasn't burst - YET. Some key excerpts (with our Nattering in italics)...
...we equity investors can just go back to our usual worries about slowing economic growth and whether the Federal Reserve will cut interest rates, right? Absolutely wrong. At least in the long run.
We're in the midst of an already huge bubble in the debt markets that's going to get bigger before it finally deflates.
That bubble is characterized by huge bets on risk in the markets for government notes, corporate bonds, home mortgages and the various synthetic derivatives based on those instruments.
The Nattering One has commented many a time on the CDO & MBS derivatives problem... And it's likely to take years to deflate -- either gently or in one big pop.
Like all pension funds and insurance companies, the New Jersey state pension fund wants to match the maturity of the financial instruments it buys to the year when those liabilities come due.
Multiply New Jersey's problem by the tens of thousands of state, local, national and corporate pension funds around the world all facing skyrocketing future liabilities...
...then add in insurance companies and other institutional investors also looking to generate cash flow to meet the demands of aging investors,
and you'll get global bidding for debt instruments with the highest possible projected returns and acceptably low projected risk.
The Nattering One has already commented on our huge and constantly growing Pension Funding Deficit Disorder, public (social security, state and local municipalities ) and private sector alike....
The more money there is in search of higher yields, the higher those buyers will drive prices for high-yielding debt securities, and the lower those yields will fall.
The only way to make up for falling yields, of course, is to take on more risk. The trend toward less yield for higher risk has been in place pretty much without interruption since the third quarter of 2001
Recently as defaults in subprime have occured yields on riskier collateralized debt obligations built around pools of subprime mortgages have climbed to 6.25% over the benchmark London Interbank Offer Rate (LIBOR).
At the end of 2006, according to Credit Suisse, the spread was just 3.5% over LIBOR. This recent narrowing of margin spread has raised yields and lowered the prices of the debt instruments.
The Nattering One has already commented on the narrowing of these margin spreads, and thus higher risk environment typified by a recent uncharacteristic lack of defaults in these high risk debt instruments...
Default rates among the issuers of corporate junk bonds, (high-yield, high-risk debt), peaked at close to 12% at the end of 2001 and have declined ever since to stand at just 1.6% in February 2007...
The average for the past 25 years is a default rate of 4.7%. From 2001 on, rates and return have been low while prices and risk have gone higher. The recent unwind and narrowing of spreads is the first round in a debt market deflation.
These investors will play the game until it comes crashing down around them, because they don't have a viable alternative other than investing billions in cash they don't have in underfunded pension plans.
As long as economic growth looks halfway decent, these investors will hang on, no matter how deep their doubts and worries.
If these investors, with their exposure to high yield and long maturity debt, can just hold out until the Federal Reserve cuts interest rates, they'll make a killing. The prices of risky, high-yield, long maturity debt soar when interest rates decline.
Five things to contemplate: 1. The debt bubble is much larger than subprime. 2. The possibility of Fed lowering will put a temporary floor in the debt market, delaying the debt market deflation.
3. The debt bubble will burst with an economic downturn. 4. Expect more episodes similiar to the last few weeks as "trapped" debt market participants attempt to unwind their positions.
5. The Baby Boomer crisis that is about to sweep Euro-peon and US markets in the next few years.
In the U.S. alone, 77 million baby boomers are on the verge of retiring. This will wreak havoc on Social Security, private pension systems and the health care system.
To pay for these benefits, a massive equity sell off and in particular debt liquidation will have to occur over several years. This sell off could create a long term market decline in the U.S.
Of course, if the Fed does lower, which they will have to by the end of summer, the long term high yield debt already held would go up in value and could well finance part of the pension deficits.
That is if the derivative based MBS backed CDO's don't implode by then.... CCR... "I see the bad moon a-risin'. I see trouble on the way."
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