Exceprted from Archaea Capital letter to investors,
Blind faith in policymakers remains a bad trade that’s still widely held. Pressure builds everywhere we look. Not as a consequence of the Fed’s ineptitude (which is a constant in the equation, not a variable), but through the blind faith markets continue to place on the very low probability outcome – that everything will turn out well this time around.
And so the pressure keeps rising. Managers are under pressure to perform and missing more targets, levering up on hope.
As we wrote last year, bad companies were allowed to push their debt up in order to pay generous shareholder dividends and director packages that are now (in an uninspiring turn of events) higher than their free cash flow. Buybacks are “all-in” at cycle-highs, funded with shareholder money while insiders continue to cash out their own. Individual investors pressured to pick up yield became their debt or equity holders – lured by higher returns, easy-to-use ETFs, and asking no questions.
And so, just as Moody’s suggested a year ago would happen (and we presented in last year’s report), high yield spreads have widened all year – in stark contrast to the gains in stocks and one of the most supportive government Bond rallies in history.
The default cycle doesn’t appear to be that far off anymore, and not just in U.S. markets. Credit markets have embarked on a new fundamental narrative – bills still need to be paid, and not everyone deserves to sell new paper at the same price.
Markets are illiquid, fractured, and in many cases unable to sustain any real test of selling.
Meanwhile it’s business as usual at the Fed, where credibility remains intact and market participants blindly expect another magic trick for Equities in the coming year.
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So BTFATH!!

