|
Last
week we touched upon the “white elephant” in the room: that the biggest, most
important bubble investors should worry about is in bonds, NOT stocks.
Consider
the following…
The
financial system is based on debt. US Treasuries, the benchmark for an
allegedly “risk free” rate of return, is the asset against which all other
assets are priced based on their relative riskiness.
This
“risk free” rate has been falling steadily for over 25 years.
The Wall Street Journal estimates that a
third of traders have never witness a rate hike. However, the real problem is
far greater than this.
Bonds
have been in a bull market for over 30 years. Forget rate hikes… an entire
generation of investors and money managers (anyone under the age of 55) has
been investing in an era in which risk has generally gotten cheaper and
cheaper.
This,
in turn, has driven the rise in leverage in the financial system. As the
risk-free rate fell, so did all other rates of return. Thus investors turned
to leverage or using borrowed money to try to gain greater rates of return on
their capital.
The
ultimate example of this is the derivatives market, which is now over $700
trillion in size. This entire mess is backstopped by about $100 trillion (at
most) in bonds posted as collateral.
This
formula of ever increasing leverage works relatively well when the underlying
asset backstopping a trade is rising in value (think of the housing bubble,
which worked fine as long as housing prices rose). However, if the asset ever
loses value, you very quickly run into trouble because you need to post more
as collateral to backstop your trade. If you can’t do this easily, the margin
calls start coming and you can find yourself having to unwind a massive position
in a hurry.
This is
how crashes occur. This is what caused 2008. And it’s what will cause the
next crisis as well.
Despite
all of the rhetoric, the world has not deleveraged in any meaningful way. The
only industrialized country to deleverage since 2008 is Germany.
This is
not unique to sovereign nations either. As McKinsey recently noted, there has
been no meaningful deleveraging in any sector of the global economy (the best
we’ve got is households and financial firms which have basically flat-lined
since 2008).
In the
simplest of terms, the 2008 collapse occurred because of too much leverage
fueled by cheap debt. This worked fine until the assets backstopping the
leveraged trades fell in value, which brought about margin calls and a
selling panic.
The big
problem however is that NO ONE got the message that leverage was a problem.
Instead, everyone has become even MORE leveraged than they were in 2008. And
they did this against an ever-smaller pool of quality assets (the Fed and
other Central Banks’ QE programs have actually removed high grade collateral from the
financial markets).
Thus,
we now have a financial system that is even more leveraged than in 2007…
backstopped by even less high
quality collateral. And this time around, most industrialized sovereign
nations themselves are bankrupt, meaning that when the bond bubble pops, the
selling panic and liquidations will be even more extreme.
The
next round of the crisis is coming, and it’s going to make 2008 look like a
picnic.
If
you’ve yet to take action to prepare for the second round of the financial
crisis, we offer a FREE investment report Financial Crisis
"Round Two" Survival Guide that outlines
easy, simple to follow strategies you can use to not only protect your
portfolio from a market downturn, but actually produce profits.
You can
pick up a FREE copy at:
http://www.phoenixcapitalmarketing.com/roundtwo.html
|
