Watch out for the blindside

Interesting article here on the dangers that exist in the fixed income or bond markets around the world.

Since the collapse of Lehman’s just over four years ago now its safe to say and it has been a wild and tumultuous ride for investors around the world. Almost at every turn new risks to the system were being discovered first in equities and the incredible over use of leverage that was been employed by not just the banking system but across the investment industry and corporate and individual sector. Then as a direct result of this lead us to the sovereign debt crisis where governments around the world were exposed for issuing far too much debt for not only their own development purposes but also in reaction to saving the financial systems of their own countries throughout the crisis. Purchasing debt instruments from sovereign issuers was always viewed as the safest of investments, always rubber stamped as triple A and generally accepted around the investment community that it was “safe as houses” and a place to hide while things were murky in other asset classes. This is usually call a “flight to safety” as what you are effectively doing is parking your money in long term instruments that provide a yield but also helps you sleep at night safer in the knowledge that the potential returns you have given up by not investing elsewhere has at the least preserved your capital in times of strife.

This concept has indeed been turned on its head owing to the tremendous problems caused throughout the sovereign debt crisis from countries like Greece, Spain, Ireland, Portugal …I could go on here but you get the idea.

Now some of the biggest fund managers in the world are looking at the situation and starting to worry that perhaps we are over invested in debt. The lessons of the last four years has led to a moral hazard of sorts whereby many feel that the risks of debt instruments have been negated by the bailout culture created by governments around the world. See the saving of the auto and financial industry in the US.

This rush to load up on debt in both sovereign and corporate bond markets has led to diminishing returns. The yield or risk premium attained from lending is decreasing owing to all time low rates in most of the developed markets around the world. Any large company that has made it through the last four years and repaired their balance sheet is likely to be able to raise money in the debt markets for relatively little cost.

As mentioned in this article all it takes is for rates to rise or inflation to rise to turn this situation very ugly and investors will, if not already, start receiving a negative rate of return. Now rates in most developed countries are not scheduled to rise until sometime in the future most likely mid 2014 or 2015 is the guidance we are used to hearing but this is just parlance from Central bankers and I would not like to stake life on it considering most of them wouldn’t tell the truth to their own mother.

You are familiar with the word ” bubble” by now and to me the best description of a bubble is when the masses start doing illogical things. It is open to interpretation whether investing in debt instrument in the knowledge that you will either receive a low rate of return, none at all or even worse a negative rate of return is a good or bad idea and wholly depends on your view of the economy over the the given period you are investing for. If you feel things are going to deteriorate at an even worse pace than the rate you will receive  then perhaps it is not the worst idea. But all it takes is a ripple in these markets to change things and the concept of overcrowding in a given asset class is a scary prospect.

Think about how quickly house prices have come off in markets where there once was a hot property market and the same thing can happen in the bond markets. A move in rates higher, a solid plan for resolution of fiscal cliff, some cohesion in Europe and a pick up in China could all cause real issues for these investors and you may witness a large rotation in asset classes of epic proportions.

Equities and commodities are the natural place for this money to end up, equities as they provide opportunities for growth and dividend yields, commodities as there are seven billion people in this world with a seemingly insatiable appetite for consuming. As I caveat so often none of this is just going to happen overnight but worth thinking about and you will start to notice the signs ever so gradually , if anything it will probably lead to the next equity bubble …… there is a sobering thought.

As the title suggests when everyone is looking one way you have to watch out for the blind side,  its usually where the punch in the face comes from.


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