{"id":38166,"date":"2022-10-17T08:42:58","date_gmt":"2022-10-17T08:42:58","guid":{"rendered":"https:\/\/thepatientinvestor.com\/?p=38166"},"modified":"2022-10-18T08:16:52","modified_gmt":"2022-10-18T08:16:52","slug":"theres-always-more-than-one-cockroach","status":"publish","type":"post","link":"https:\/\/thepatientinvestor.com\/index.php\/2022\/10\/17\/theres-always-more-than-one-cockroach\/","title":{"rendered":"There’s always more than one cockroach"},"content":{"rendered":"

There is always more than one cockroach. ~ Doug Kass, 50 Laws Of Investing<\/a> (#8)<\/p><\/blockquote>\n

Rising interest rates, soaring energy prices, and plunging exchange rates of major energy importers — Europe, Japan and China — are likely to expose widespread misuse of leverage in financial markets.<\/p>\n

JPMorgan Chase CEO Jamie Dimon says investors should expect more blowups after a crash in U.K. government bonds last month nearly caused the collapse of hundreds of that country\u2019s pension funds. The turmoil, triggered after the value of U.K. gilts nosedived in reaction to fiscal spending announcements, forced the country\u2019s central bank into a series of interventions to prop up its markets. That averted disaster for pension funds using leverage to juice returns, which were said to be within hours of collapse. \u201cI was surprised to see how much leverage there was in some of those pension plans,\u201d Dimon told analysts Friday in a conference call to discuss third-quarter results. \u201cMy experience in life has been when you have things like what we\u2019re going through today, there are going to be other surprises.\u201d ~ CNBC<\/a><\/p><\/blockquote>\n

Contagion<\/h2>\n

Financial turmoil in one market soon spreads to others as market bullishness collapses.<\/p>\n

\"Extreme<\/p>\n

Financial chaos in the UK is hitting the shores of Japan and roiling the $1 trillion global market for collateralized loan obligations. Norinchukin Bank, once known as the “CLO whale”<\/em>, has stopped buying new deals in the US and Europe for the foreseeable future because of volatility sparked by UK pension funds…. (Bloomberg<\/a>)<\/p><\/blockquote>\n

Misuse of debt<\/h2>\n

Speculators in a bull market, encouraged by the low cost of debt and the consequential rise in asset prices, borrow money in expectation of leveraging their gains. Companies, encouraged by the low cost of debt and rising stock prices, also borrow money to invest in projects with low returns or without proper consideration of downside risks should the economy go into recession. Companies may generate sufficient cash flow to service interest on their debt but insufficient to repay the capital. Their survival depends on rolling over their debt when it matures. Known as “zombies”, they are vulnerable to rising interest rates, shrinking liquidity and stricter credit standards during an economic down-turn.<\/p>\n

\"Zombie<\/p>\n

The Great Repricing<\/h2>\n

\u201cWe\u2019re seeing the beginning of the Great Repricing…and that repricing is going to have significant impacts on portfolios of many investors…But this is an inevitable consequence, in my view, of a return to more normal levels of interest rates…\u201d ~ Mervyn King, former Governor of the Bank of England<\/p><\/blockquote>\n

Rising interest rates and tighter liquidity force speculators to sell off assets to repay debt. The sell-off causes a fall in asset prices, prompting further margin calls, fire sales and a downward spiral in asset prices. Also, zombie companies, devoid of support from creditors, go to the wall. Publicity surrounding bankruptcies and layoffs raises fears of further corporate failures and increases the difficulty for borderline companies to roll over debt, reinforcing the downward spiral.<\/p>\n

The ratio of stock market capitalization to GDP — Warren Buffett’s favorite long-term indicator of market valuation — has fallen sharply to 211% (Q2) but is still well above the Dotcom bubble high of 189%. And a long way from the long-term average of 104% (dotted red line below).<\/p>\n

\"Stock<\/p>\n

Government intervention<\/h2>\n

Attempts to support inflated asset prices, as in China’s real estate markets<\/a>, prevent markets from clearing and merely compound the problem. They simply prolong the bubble, allowing further debt accumulation and increase the eventual damage to financial markets.<\/p>\n

No soft landing<\/h2>\n

In the past few recessions the Fed has stepped in, injecting liquidity to end the deflationary spiral but this time is different<\/em>. The recent rapid surge in inflation has tied the Fed’s hands. They cannot inject liquidity to slow the rate of descent without risking a bond market revolt as seen in the UK.<\/p>\n

\"30-Year<\/p>\n

Portfolios with a 60\/40 split between stocks and bonds are showing their worst year-to-date performance in the past 100 years as both asset classes suffer from shrinking liquidity.<\/p>\n

\"60\/40<\/p>\n

Conclusion<\/h2>\n

\u201cThe investor who says, \u2018This time is different,\u2019 when in fact it\u2019s virtually a repeat of an earlier situation, has uttered among the four most costly words in the annals of investing.\u201d ~ Sir John Templeton<\/p><\/blockquote>\n

We should not underestimate the ingenuity of governments and their central bankers in postponing the inevitable pain associated with sound economic management. Instead they kick the can down the road, compounding the initial problem until it assumes Godzilla-like proportions, making further avoidance\/postponement almost inevitable. It takes the courage of a Paul Volcker to confront the problem head-on and restore the economy to a sound growth path.<\/p>\n

The million-dollar question facing investors is whether Fed chair Jerome Powell can do another Volcker. But Volcker had the advantage of a federal debt to GDP ratio below 50% in 1980. Treasury could withstand far higher interest rates than at the present ratio of well over 100%. So Powell is unlikely to succeed in meeting financial markets head-on.<\/p>\n

\"Federal<\/p>\n

We expect the Fed to pivot. Just not this year.<\/p>\n

Acknowledgements<\/h4>\n