Many times I write things like there is an everything bubble, asset prices are grossly overvalued and it appears that a major correction is just a matter of time. Of course, I’m just a simple financial advisor who happens to do a lot of macro research and I have been seeing these problems for going on 10 years now.
So far, those who have taken risks may have been rewarded. Any attempts by the stock and bond markets to do their jobs- reveal true value- have been swiftly met by freshly “printed” money and asset purchases to, it appears, make sure these markets stay elevated and don’t cause any panic to those taking more risk than they may have taken when interest rates were more normal.
This has gone on for so long now that many are beginning to believe this type of behavior is normal and, even more dangerous, that it can just go on forever. It can’t.
This is me saying it can’t and I will back my statement up with a few ideas:
- Since I believe that conjuring money up out of thin air and buying real assets is theft from all of us this is subject to the statement that every fraud contains the seeds of its own demise. Don’t forget that one!
- This is an “everything” bubble. The IMF (International Monetary Fund) put out a release for April 2018 that said : Against a backdrop of mounting vulnerabilities, risky asset valuations appear overstretched, albeit to varying degrees across markets, ranging from global equities and credit markets, including leveraged loans, to rapidly expanding crypto assets. My comment: In plain English most assets are overvalued and there are many risks that are apparent that could cause these assets to have a meaningful correction.
- IMF again: Against a backdrop of low default rates, corporate spreads remain at very low levels, even in the riskiest segments. The share of lower grade bonds (BBB-rated) in the investment grade universe has been rising. Strong issuance and lofty valuations, including a weakening of non-price terms such as investor protections, could exacerbate the next default cycle. A sharp rise in defaults following a tightening of financial conditions, or a shutdown of the market at the extreme could have large negative implications for the real economy given the growing size of the loan market to date and the role it plays in funding to corporations. My comment: First of all I find it interesting that the IMF mentions a system shutdown in a mainstream report. 1 Second, in a normal economy when a lender is lending to a less than pristine borrower many times there are certain covenants that the borrower must conform to so that the investor has better protection against default. Recently, many covenant-lite loans have been the rule which means little-if any- additional protection is afforded to a lender taking a larger than normal risk. This is on top of absurdly low interest rates that make the risk even higher.
- As I have mentioned before margin debt is at all time highs. This can lead to sharp corrections because the margin clerk would sell whatever is necessary to cover the margin at that time. IMF again: Sharp price declines can lead to investor runs and fire sales of liquid and safe assets to cover redemptions and margin requirements. They also cite synthetic Collateralized Debt leverage used by hard-to track investment funds.
- The rise in ETFs, particularly those investing in relatively illiquid assets may increase contagion risk and possibly amplify price moves across asset markets during periods of stress. Greater investment in passive investment strategies, such as ETFs, may be related to the rise in cross-asset correlations during periods of stress, one of the main attributes of contagion.
This statement pretty much explains what I mean when I say that from 2003-2007 all assets moved higher together and in 2008-2009 all fell together. The idea of diversification was turned on its head. Something similar may be brewing as we speak. A simple explanation would be that everyone heads for the exit at the same time. Many times, there are no buyers until the asset prices are far lower.
I have also noticed that many funds that you would expect to be somewhat “safe” like muni funds, etc. are carrying leverage that you would not normally expect in a fund such as this adding many times the risk an average investor would expect. If anyone looked at this a little closer they may not be surprised at the level of volatility that may take place when rates rise or redemptions begin. Buyer beware.
The IMF also mentions house prices that have been rising mainly because of accommodative monetary policy in many areas of the globe. They raise the possibility that financial instability could arise if those accommodative conditions should reverse- which they appear to be doing.
I have often noted that, as housing prices have risen, incomes have not even come close to keeping pace. People are spending a larger percentage of income on housing (particularly the younger generation) and because interest rates are artificially low they can go into greater debt with lower monthly payments than if rates were more normal- aren’t they lucky?
I wanted to put this out because who is going to read an IMF report? It has been my experience that before any major market disruptions or change in trends there have always been warnings by those in charge and, after the fact, a statement that we said such and such just a few months before the event- Kind of like- “We told you- why didn’t you listen?”
Of course, they know that few people pay attention to their releases. This allows them to keep getting away with doing the same thing every 10 years or so.
Pay attention folks- things are heating up.
Mike Savage, ChFC, Financial Advisor
Securities are offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc.
Any opinions are those of Mike Savage and not necessarily those of RJFS or Raymond James. Expressions of opinions are as of this date and are subject to change without notice. The information in this report does not purport to be a complete description of securities, markets or developments referred to in this material. The information has been obtained from sources deemed to be reliable but we do n ot guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.
Diversification does not ensure gains nor protect against loss.
1- All references to an IMF report are from an IMF report from April 2018 named Global Financial Stability Report : A Bumpy Road Ahead