Mish, you are correct. There are a lot of skeletons in the closet that I fear will be exposed when we least expect it. In a perfect world, inflation/stagflation SHOULD occur based on the CURRENT economic conditions, but the wildcard is the debt and there is a HELLUVA lot of it which is going to vanish in thin air.
I recently sent my colleague a graph of the yield spread versus the corporate default rate. Of course defaults tend to pick up when the yield curve inverts due to economic slowdown and while current default rates are relatively low, there has been an increase in the last few months. Meanwhile, credit spreads have actually tightened in the past few months. Something is wrong in Dodge, WTF?
Here's the answer:
There is a huge "artificial" bid coming from Collaterized Debt instruments. These products effectively take a basket of bonds, create a structured product (derivative) which is 10x leveraged (let's not get started with CDO squareds). We in the HF community know it's served to keep things tight, but never in my mind could I imagine the amount of distortion until I saw it last month. Amazingly, last month while Emerging Market spreads were blown away, and the equity market sold off relentlessly, CCC spreads - (distressed paper) barely budged. In fact the whole US credit curve didn't move significantly. In June 1999 when we had a similar default rate as today and a steeper yield curve, high yield credit spreads were a full 200 basis points higher having troughed in the summer of 1998.
Never before has the world seen such insane leverage and Bernanke doesn't have enough keys on his computer to create the amount of liquidity needed to bail this sh!t out when it busts.
Unlike LTCM, there are multiple players involved who all went to the same schools, do the same credit work, and basically own the same thing. These people are very smart in a micro sense, but I am afraid they have missed the forest from the trees. Let's not forget the counterparties and prop trading desks who are also in the mix.
We will all wake up one day to a new financial world, I guaranteee this. Even if you want to short (credit), I don't think you'll have a chance because the market will seize up...overnight. Equity will obviously get killed as well because valuations have been predicated on access to cheap credits.
I just don't see how it can get crazier than this. And I mean that. One could make an argument that there were some pockets of undervaluation in asset classes in 2000, but now???
Would be interested in anybodys comments (excuse the typos, I am not wearing my glasses). |
