Welcome To The Riskless Market

Tyler Durden's picture

Authored by Anthony Peters of SwissInvest, via IFR,

Risk is a four-letter word

The markets seem to think we live in a largely riskless world.

RISK IS A funny old thing at the best of times, and even funnier when it is supposed to be correctly priced.

Most of us grew up with the understanding that the correct price for credit – my main area of expertise – was a function of the default probability, adjusted for the expected recovery rate.

Perhaps the simplest and cleanest example of risk pricing is to be found in the credit card industry, where your “bucketing” is of paramount importance. The lower your perceived risk is, the better a risk bucket you get lumped into and the lower your interest rate is. That’s banking 101, but it still isn’t clear to everyone that the net earnings from each bucket are expected to be similar, based on higher spreads being matched to higher defaults. Excess returns are generated when the expected defaults do not occur at the forecast rate.

So far, so good. But then how does one extrapolate that basic rule of lending to the way credit markets have been performing of late?

My old chum Suki Mann, living legend and credit strategist at Societe Generale here in London, highlighted the point – albeit probably not intentionally – in a piece he wrote this week. He asked, rhetorically, whether it would be possible for the credit markets to repeat this year’s performance in 2014 – wondering, in other words, whether a further 8.4% of returns on 220bp of spread tightening in high-yield or 2.4% returns with 22bp of spread tightening in investment-grade were possible.

“We’d concur with the former,” he wrote, “but up to 7% is not impossible off 100bp of spread tightening; while in IG, we think 2%-plus is possible with tightening in [iBoxx] index spreads of around 30bp.”

Although I don’t entirely disagree with Suki, I can’t detect too much science going into his pricing model, if that is what it is. The sole point of reference seems to be the all-time low spread of the iTraxx Main index, which was registered at 20bp in June 2007. As recently as early October it was trading at 100bp but is now marking around 75bp. Hence, his rather confident assertion that a further 20bp of tightening should not be a problem.

PERHAPS, BUT ONLY because the first rule of investing now appears to have become: if the worst is about to occur, then the monetary authorities will make sure that it doesn’t.

Let’s face it, Saint Mario Draghi did not only say that he will do “whatever it takes”, the bit of his assertion everyone remembers, but also, and perhaps more importantly, “…and believe me, it will be enough”.

In doing so, he removed huge swathes of what we once called risk – a concept that used to be known as a four-letter word. This raises the question: are risk assets now riskless assets or are they risk assets disguised as riskless?

What goes for bonds appears to go for equities too, even though we did experience something of a wobble in the summer when the US Fed seemed set to taper its bond buying programme. Since then, though, the Fed, in its own inimitable way, appears to have let equity markets believe that it will do nothing that might hurt share prices and hence shareholders. If anything, the velocity of the rally now appears to be increasing rather than decreasing.

Either the Fed is deceiving markets into believing that there is nothing to fear, or it is not making itself clear enough. To be frank, I doubt it is the latter.

SO WHAT HAS become of risk pricing? Well, one might try to argue that if there is no risk, then there can be no price for it. But that would be perhaps taking it a little bit too far – even for me.

Nevertheless, pricing risk has become so alien that even non-monetary policy-related risks are being disregarded. The little tiff between China and Japan (and by proxy the Americans) over a group of uninhabited islands never even caused a ripple in financial markets. And although it was written that oil prices had fallen in the aftermath of the interim agreement between Iran and the West, if one looks at the charts, WTI was trading well below its 300-day moving average long before the news broke – and the Geneva breakthrough doesn’t appear to have even registered.

Is there no risk or has the way in which authorities prevented the fallout from the credit bubble and the events that led to its formation led a generation of traders and investors to believe that it is a thing of the past?

One hedge fund manager once proudly stated that life is a bull market intersected by corrections. In the midst of the credit crisis I laughed at him.

Looking at the state of the world now, he might be laughing back, having concluded that the 2007 financial crisis and the 2008 fall of the House of Lehman were nothing more than bigger corrections and hence thumping buying opportunities that could only have been missed by idiots.

I guess that puts me in my place. Either that or there is something lurking out there that we have forgotten how to identify – and hence how to value.

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slotmouth's picture

The best strategy that I can think of is to capture Australia early on.

tarsubil's picture

That's what I do. Easy to defend and quickly gives bonus armies.

aardvarkk's picture

Nonesense.  With Australia, your only next step is to capture Asia, which you usually can't do because some butthead is trying to hold Europe/Africa by hanging on to the ME/Ukraine combo as a shortcut.  Much better to base in the Americas with only three defense points and then metastasize to Africa with the right timing.  With the added bonus of being positioned to deny both Europe and Asia to the butthead sitting down isolated in Australia with his puny 2-army-per-turn bonus.

The above is even more true if you actually follow the max-12-army-per-country rule, which we never do.  Can't have an epic battle with only 12 armies.  (I *think* it was 12...haven't played for years).


sunaJ's picture

Since 2008, there has not been a clearing of misallocated capital destruction as in the past bubbles (even if these were only partial clearings), so the fed ambled-up to the bar during the crisis to do its job again, only now we have been funding at greater velocity the continued misallocation of capital from the previous crisis and whatever else we have invented to sell to people.  The continuation of this misallocation is driven by the desperate blindness that comes from an ideology in its death throes, and the incredible amount of fraud that if fully-known or allowed to "clear" would unravel this world of make-believe.  Each passing day without a reset represents days of wealth stolen from this and future generations.  Those who uphold this wretched system can only go more speed ahead...until it breaks.  I consider it a consolation in the madness to understand that it will break, and that I have some time to figure out how to best preserve my capital.

Supernova Born's picture

The Fed is attempting the first version of the Matrix that a functioning human mind simply cannot accept as real.

Rational thought comes right after gold on the Fed's hit list.

superflex's picture

Kamchatka is the key and who reads the rules.

Zero Point's picture

Never, ever try to hold Asia. No matter how easy it might look.


NoDebt's picture

Never wage a land war in Asia.  Just drag them into a resource-sqandering battle in Afghanistan:  the graveyard of empires.

We're talking about a board game, right?


TheReplacement's picture

Right on.  SA to NA to anywhere, but usually Africa.

Yardfarmer's picture

here's some kinda risk. how about that BTC? plunges 32% to $842 on heavy volume.

NoDebt's picture

Yesterday's news.  Just shy of $1100 last trade.  Not that I follow stuff like that.

RaceToTheBottom's picture

Risk is gone.

Price discovery is gone.

Accounting is gone.

Meritocracy is gone.

Welcome to the new normal.


AlaricBalth's picture

Why not roll the dice on this market and bet it all. The worst that can happen is that I lose everything.

After that, it's easy street. I get free SNAP food, an Obamaphone, free healthcare, all the pain killers I want (you know, bad back!), which I can sell to my friends for extra income, rental assistance, low income energy assistance, free career and psychological counseling, a disability check each month (because I am clearly crazy!) and the peace of mind knowing I never have to work again.

So where is the risk???  Moral hazard is no more!!!

max2205's picture

Oh fuck this guy and his rear view mirror analysis

Abi Normal's picture

Risk Averse!!! At least you ought to be...I can't count the number of BIG risks that are floating in the air out there!!!! Go for it...heheheh.

Rainman's picture

There's a black swan hiding behind every blade of grass.

Don't be pissed if you're not a Detroit city pensioner....7.9% .. risk free...hahaha


ebworthen's picture

And it is precisely the avoidance of risk via central planning that induces the greatest risk.

Mandlebrot will be vindicated from beyond the grave just as surely as the cycles of the tides and moon.

XRAYD's picture

Risk on, risk off, risk NO!

Renfield's picture

Central planning seeks to obviate risk.

Unfortunately, it creates greater risk, by the fact that the greater the degree of intervention, the less free price discovery occurs, and the more reliant the public becomes on the integrity and ability of planners. Without free-market price discovery, price becomes divorced from value.

I think we're about at the stage where the market is so centrally planned, very little real pricing remains, and personally I think this is why government currency is showing signs of repudiation.

When our paper market measures - our currency - no longer work to buy items we use each day, or even to show what the price of such items should be, then we are reaching the end of the useful life of our currency and our market.

They'll keep shambling around for awhile, though. Zombie banks have morphed into zombie markets, and zombie currencies. More of us are moving, at an accelerating rate, into whatever the next currencies or markets will be. I hope soon we'll begin to understand the new currencies and markets that are now beginning to form.

fonzannoon's picture

Renfield where are you seeing government currency showing signs of repudiation?

Westcoastliberal's picture

It's a "no risk" world until all the "very serious people" of the 1/10th of 1% have adequately hedged, then it will be risk on full bore.  Of course, we plebes will have zero warning of the timing...it's all about the timing.

buzzsaw99's picture

stocks carry the federal reserve seal of approval. all other investments, i.e. gold, bonds, etc., are verboten and will be punished. btfd or die hideously.

Alcoholic Native American's picture

Just hit the buy button, the TV shows have already shown that "circuit breakers" are cut when the market goes down.  

docmac324's picture

Just an athiest, doing God's work...

fonzannoon's picture

There is risk everywhere in this market. Risk to traders. Risk to money managers. Traders can easily find themselves on the wrong side of the churn. 99% of asset managers are going to be laid to waste by the S&P. 

At the same time however the S&P will reward pensions and everyone else who joins the party and takes the ride.

Professorlocknload's picture

Risk of Deflation, nada.

For everything else, there's Mastercard.




starman's picture

Ah...you've lost me

Kina's picture

So if China dropped $500bn USD on the market...how much would the value of its gold holdings increase as a result.

China drops $500bn.... others race for the exit with another $500bn USD ...... gold goes to parabolic ...China loses nothing in value of reserves.

The nations holding gold have insurance against the USD.


Message to China:

The US knows its economy and currency are totally fucked. Their next strategy to save its currency and economy is to push China into a major war.

Dump your USD before they dump you in it. 


The US is goading Japan and China and the rest to spark a conflict.

centerline's picture

Don't discount the EU being more screwed.  US markets provide liquidity for capital flight - and the USD could appreciate significantly in the process despite billions in FED $ pumped into the system (which isn't going into loanable funds anyhow).  London and Wall Street are the sharks here... just waiting for the next boat to capsize.  Err... more like making waves to get it to topple over.

chump666's picture

I'd say China is dumping USTs (10s) and USDs, the line is 80 which could be a the Feds Gustav line.  80 break could mean a $ crisis, that plus the UST short end market sells hard.  This would equate to Yelland's attempt at buying all the 10s. The spec trade in stocks will continue creating a larger bubble, then we have a war i.e Japan/China.  Market panics and BOOM!...


chump666's picture

Communism tried to remove risk, early Utopian philosophy ala French prior to the 1900s believed it could be done.  Deterministic scientific theory (now disproved) attempted to do the same.  Humanistic systems are not nature based systems, they are solely confined to our chaos, psychosis and bullsh*t = which means pure adulterated cronyism. 

We are ruled by academic lunatics and disgusting leaders.

Chop, chop...


Skateboarder's picture

Great post. The key to controlling an entire sapient species (without physical coercion) is illegitimate legitimacy. It is through this false dichotomy that man is held hostage.

chump666's picture

That is right.  Only we can break that bondage, the cronies will take this is far as they can, no doubt there.  In my opinion, I think humanity is kinda ashamed that we are repeating that historic cycle once again.  It is clear that Obama is probably the worst president in the last 50ys i.e nearly starts WW3 (Russia), allowed most probably armed B52s to fly through China's new flight zone, attaches Washington to Wall Street, allows the Fed to be a rogue entity etc etc etc. Isn't this supposed to be the future and we have 'advanced'? Very similar (historically) to the 1870s through to the 1900 when everything was supposed to be Utopian. 

We are very good at fooling ourselves.

Goldilocks's picture

Make Mine Freedom - 1948 Anti-Communist Propaganda Cartoon
http://www.youtube.com/watch?v=8D6d6_-Vngo (9:31)

falak pema's picture


But its controlled by a new aristocracy not by socialist state. So get your semantics right. 

The oligarchs control it and the first world states, drowned in debt, have to play along; UNLESS the ponzi blows; whence the need to control it centrally more and more.

Oldwood's picture

I don't get the argument. Doesn't every government system that is a top down, unaccountable, rule by fear and greed system have its own aristocracy? Any of these systems (implying an artificial construct imposed upon an economy) rely on a power structure ruled by people who present the illusion of popular selection while pretty much doing whatever they want. I'm really tired of socialism, communism or even our current version of capitalism (which I do not accept as capitalism as it is artificial and corrupt by those very same aristocrats you point out) being thrown about because it is another way of dividing people into camps. We know there are some, if not many here who have sympathies towards what they believe to be socialism and tend to knee jerk resist negative connotations. Regardless of what "system" we love or hate, we should be willing to agree the problem is one of corruption and should also agree that corruption is greatly amplified by concentrated centrally controlled authority. My preferred system is "freedom" and all of the evil bad shit that it includes.

falak pema's picture

Democracy and Republic are NOT UNACCOUNTABLE...

Your statement is historically fallacious if the people PUT THEIR MINDS TO defending THEIR CONSTITUTIONAL rights!

The basic lesson in history is that life is a struggle in organized society; AND prominent amongst those struggles is the CLASS or economic wealth struggle and the means that Oligarchs have of cornering the market and government.

So if the lessons of history are clear and have been documented WHY do PEOPLE fall into AMNESIA?

Today the first world populations are being LED by their noses by these corrupt shills and are DOING NOTHING about it in terms of exercising their inalienable rights of republic and democracy.

More fool them. 


adr's picture

If I'm low risk I'm supposed to get a better interest rate? Better tell that to my bank.

840 credit score, 14% APR. Wife has a 650, 14% APR.

I go to get a used car for my wife, Wells Fargo denies my loan at 3.9% but says I can get 6.9%. I tell them to go fuck themselves. I just went to my credit union and got a loan at 1.9%. My aunt who has a credit score under 500 gets a loan through Wells for a brand new $15k car.

Our system is fucked beyond recognition.

Skateboarder's picture

The notion of investment is inverted - a lack of investment, or credit, more broadly, is an 'investment.' Therefore an ROI depends not on the borrower's ability to pay but rather his inability to pay. Now take the last two sentences and leverage them a quadrillion times backed by nothing, and we are here where we are today.

Oldwood's picture

From each according to his ability, to each according to his need. Its all affirmative action, wealth redistribution. If you actually indicate you can pay they demand interest tribute, but for those broke ass bottom sliders, somebody has to pay!

ToNYC's picture

....where riskless assets morph into risky liabilities.

Kina's picture

I think once China dumps USD in bulk it overwhelms any counterbalance, too much at a time. Europe wont be able to help...and will sink trying and eventually dump to not get caught out holding confetti.....else it becomes confetti...they will want to put something under their own currencies.

China loses bns in USD devaluation but gains countless billions extra on gold sliver revaluation.


This might end up being mutually assured economic chaos...however if the US is persuing a strategy to get China into major armed conflict...then it would be best to strike first for best result. The Yuan becomes the strong and gold supported currency de jour.


Any scenario that involves the return of gold into the currency equation by neccessity will see it revalued by orders of magnitude.

Kina's picture

Kissenger and Co wanted to demonetise gold to keep the US in charge of the globe.

But it doesn't work, when chaos is around gold is the go to....and chaos comes in size once every generation or two.


Now Asia and Russia have loaded up in gold in bulk....so US/CIA attacks on China lose one facet..undermining currency...where they have shot themselves in the foot.


AND do they want war in Europe..aka Ukraine, Russia et al ... which will precipitate a break up of the EU? Russia & China becomes the economic winner in that scenario picking up lost production and repositioining themselves in some Europeane states.

DOGGONE's picture

Get your heads out into the light and just look at these compelling price histories!

Godisanhftbot's picture

 Let's face it, all you needed to do was buy a stack o'bitcoins a few years ago, and you could have given up posting here forever.