FYI | Jun 28 2007
Amidst all those scary stories about Bear Sterns and other professional investors in the US who may get caught out because of too eagerly acquired, improperly valued sub-prime loans, it is easy to forget that the real story for global equities still revolves around bond markets and the attached yields.
Although both themes are closely intertwined, of course.
If we adhere to the cockroach theory that whenever you spot one there are more hiding elsewhere the coming weeks, possibly months will see more negative headlines stemming from the US housing and sub-prime markets. This seems but a fair assumption and certainly people in my daily environment can confirm this has been my personal view over the past few months.
Even though many people would like the looming problems in the US to simply go away, and authorities and financial institutions will certainly put in their best effort in calming everyone’s fears, it should be clear to everyone that they won’t.
So what are the dangers we are looking at? In a special report on the matter, analysts at Intersuisse put it as follows:
“Although US Federal Reserve Chairman Bernanke claimed that the subprime meltdown will not significantly impact the US economy, there are two issues.
“The first is the impact on the US economy where higher lending requirements and interest rates could contribute to a decline in consumer spending and increased selling of property resulting in a decline in the value of a home. This could result in further economic slowdown as consumers reduce spending because of the lost value of their home and higher unemployment as companies retrench workers due to declining spending into the US economy. This could result in retarded business growth, particularly in retail, discretionary items and new financings; which will spread to other economies exposed to the US economy; being mostly Japan, Europe and Australia.
“The second [issue] is the losses that financial institutions and banks may experience through collateralisation of these loans. In the event that major banks cannot unwind their positions, losses could occur due the write-down or write-off of collateralised subprime mortgage loans.”
After reading such assessments the logical conclusion to draw seems to be that US interest rates are very unlikely to move higher anytime soon. Those who have kept a close eye on the US bond market recently will have noticed that bond yields in the US have retreated a little and seem to be stabilizing just above 5% – with investors no doubt awaiting more concrete signs about the future direction.
But things are never that simple. Some economists seem to be prepared to bet their title on that inflation will pick up in the quarters ahead. “Food-inflation” has become the new buzzword. In addition there is still the desire of Asian central banks to buy less US Treasuries and everyone from Russia to the United Arab Emirates would prefer some less US dollars in their vaults as well.
Behind all these factors and contemplations is the growing market acceptance that the end of low bond yields is nigh. Some commentators believe it was not so much the sudden spike in US bond yields that scared the global investment community earlier this month, but merely the realization that the era of unusually low bond yields is gradually coming to an end.
Some have already dubbed it “the end of the twenty year bull market” (for bonds).
Singapore’s Business Times newspaper organised a panel of expert voices recently which was supposed to exchange thoughts and views on the global bull markets but bonds, and the aforementioned end of an era, took center place in the discussions.
(A report from the panel discussion was forwarded to us by one of our readers. Thank you very much for this Regina.)
As per his usual self, some of the more eloquent contributions to the discussion were provided by Marc Faber, author of the Gloom, Boom and Doom Report. It certainly makes for some scary paragraphs.
Markets are currently experiencing the onset of a major bear market in global bonds, Faber believes. This should take yields back above their levels of 1981 when US Treasuries were yielding 15% (not a typo) in a process that will take at least ten years.
(Other participants were not necessarily as gloomy but they agreed with the fact that bond yields will increase to levels well above to what the world has become accustomed to).
Faber believes that excess liquidity is gradually drying up. The problems that have surfaced over the past few months are simply the first casualties in this process.
There is no consensus about the exact implications, or of the timing of events, but the majority of the panelists seem to agree that the outlook for 2008 is increasingly looking darker. Sure, China will be taking the global centre stage through its Olympics, but maybe the Chinese authorities will lose some of their vigilance once the whole parade is over?
Another source of concern seems to be a potential Democrat as the new president of the US in 2009 as it is likely to open the door to less investment friendly policies, including protectionism. Especially if the US economy is in dire straits by then, one of the panelists said.
There is a fair chance financial markets may start anticipating these dangers in 2008 already.
The biggest danger, of course, comes from the unsuspected event. War. Conflict. Natural disasters. Iran. Iraq. Palestina. Russia. Venezuela. Nigeria. Take your pick.
Several panelists argued that, given the current state of global markets and the fact that one cannot prepare for such things, and put within the framework as discussed above, we could be talking about inflated assets, such as equities, losing 50% of their value.
However, let’s not lose ourselves in fearmongering and concentrate on the key message instead: the world is changing.
The sooner investors come to grip with this the better the investment decisions that will be made.
Till next week!
Your I am an old time fan of REM myself editor,
Rudi Filapek-Vandyck
(As always supported by the Fab Three: Chris, Terry and Greg).