Wednesday, September 2, 2015
Fund, Fund, Fund till Her Daddy Takes Her T-Bill Away
Global stock markets crashed, a sudden panic based on pent-up fears that have been festering long before the market peaked. Logic could not allow otherwise. Here in the United States, for example, we have experienced 12 consecutive years of contracting levels of average discretionary income, the money stuff consumers use to buy stuff. And while consumers have benefited from falling prices at the pump, a whole lot of companies have watched their underlying values erode. A contracting middle class is not a good bet for solid market growth.
There was only so much value-growing that could increase from laying people off, increasing the productivity of those who remain, financial restructuring, etc. There may have been bursts in pent-up consumer demand, like in the car marketplace, but remember that while Americans replaced their vehicles every two years in the 1960s; today it’s every eleven years. If people have less money to spend, then the companies they buy from will make less topline revenue! Duh! But the bond market has had its own special piece of this suffering.
Globally, economies from Europe (with its Greek crisis) saw the euro tank, China’s watching its manufacturing sector slip, Russia, Brazil and the Middle East (not to mention Canada and the United States) have witnessed a drop in oil and gas prices… and signs that bonds were everywhere slip-sliding away. Particularly government debt – look at our own Territory of Puerto Rico, our version of Greece – or debt based on governmental-supported commodities producers.
If bonds are priced in local currencies, and those currencies devalue voluntarily (China) or involuntarily (Europe), bond-holders from countries with stronger currencies lose. They could lose twice: once if the currency is worth less, but maybe again if that devaluation suggests a failing economy and perhaps an inability to honor the bond itself. For those nations who have borrowed (via bonds) from a nation with a strong currency (and in that stronger currency as their local currency falls), the bond debt has effectively skyrocketed by the amount of the devaluation. With a global malaise clearly returned, risks in the bond world are increasing… and risk means bond yields have to go up.
So much of American invested capital, maybe even money from your own pension plan, is socked away in this bond debt. It may not be directly obvious to you… it might be buried in that mutual fund that hides in the corner of your portfolio (if you even have a portfolio anymore) or in the investment portfolio of a corporate investment that supports the company’s retirement commitment to you. And the yields of bonds from emerging markets have been particularly hot in the last few years… but it is precisely in those emerging markets, or markets that are heavily based on the assumption of endless commodities growth, where the biggest issues have grown fast.
And trust me, whatever negativity Americans might feel about the countries from which many of these money emanate, American funds have been buying bonds from companies and governments all over the world. “Brazil, China, Malaysia, Russia, Turkey and others have sold more than $2 trillion in bonds, mostly to American mutual fund companies, since 2009. As this money flowed into their countries, financing skyscrapers in Istanbul and oil exploration in Brazil, economies and currencies strengthened… Now the reverse is occurring, led by a slowing Chinese economy, and as that money heads for safety, local currencies are plunging…
“Among the many beneficiaries of this largess were commodity-driven borrowers such as the state-owned oil companies Petrobras in Brazil and Pemex in Mexico [scandal land!], the Russian state-owned natural gas exporter Gazprom, and real estate developers in China.
“One of the more extreme cases of this bond market frenzy was Mongolia. In 2012, with expectations high that the relatively tiny economy would reap the benefits from China’s ceaseless appetite for raw materials, the government sold $1.5 billion worth of bonds, with demand from investors reaching $10 billion… That meant, in effect, that the country was in a position to borrow an amount twice the size of its $4 billion gross domestic product.
“Three years later, the International Monetary Fund is warning that Mongolia may not be able to make good on these loans — 14 percent of which are owned by Franklin Templeton, according to Bloomberg data — and the yields have shot up to about 9 percent from 4 percent… Of course, a Mongolian bond deal gone bust does not spell disaster. But it illustrates the risks global mutual fund investors were willing to take on in their desire to load up on high-yielding securities.” Landon Thomas, Jr. in Deal B%K.com, New York Times, August 22nd.
This bond feeding frenzy has been massive, and U.S. trading companies are heavily invested. But today there are new risks, elevated to a “red alert” level. “In January, economists at the Bank for International Settlements, or B.I.S., a clearinghouse for global central banks, published a study that highlighted how fast dollar-based lending to companies and countries outside the United States had increased since the financial crisis — doubling to over $9 trillion.
“What struck the authors most was that this growth was coming not from global banks but from American mutual funds buying the bonds of emerging-market issuers… Large fund companies like BlackRock, Franklin Templeton and Pimco and have been inundated with money from investors eager to invest in the high-yielding bonds of emerging-market corporations and countries.
“For example, Pimco’s Total Return bond fund, which last year suffered the loss of its star manager, William H. Gross, and is a mainstay for investors with fairly conservative investment goals, has 21 percent of its $101 billion in assets invested in emerging-market bonds and derivatives…
“‘The growth rates for many of these countries were vastly overstated,’ said Dani Rodrik, a professor at the Harvard Kennedy School of Government who has studied the impact of foreign capital flows in developing economies. ‘It was all very unsustainable.’
“The selling spree has raised concerns among regulators and economists about a broader contagion that could make it difficult for individual investors to withdraw money from their mutual funds… While these funds do not use borrowed money, as did the banks that failed during the mortgage crisis, they have invested large sums in a wide variety of high-yielding bonds and bank loans that are not easy to sell — especially in a bear market.
“If investors ask to be repaid all at once — as happened in 2008 — a run-on-the-bank scenario could unfold because funds would have difficulty meeting the demands of people wanting their cash back.
“During previous global investment booms and busts, large commercial banks were the dominant overseas lenders. These institutions were just as prone to making bad lending decisions as bond investors, but they also tended to have longer-term relationships with their borrowers and were less likely to cut and run… Because large global banks suffered significant losses during the financial crisis and were forced to rein in their lending, more nimble — and fickle — bond investors stepped in.” NY Times.
You can picture what happens when a market begins to level trading expectations with hard economic reality. Not pretty, but it has happened and it is going to continue to happen. For emerging markets already under heavy debt loads, effective costs will grow, and God help them if they need more. But if panic sets in and buyers want their money…
I’m Peter Dekom, and what you don’t know can kill your or break your bank!