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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
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