Bill Blain: "Stock Markets Don't Matter; The Great Crash Of 2018 Will Start In The Bond Market"

Blain's Morning Porridge, Submitted by Bill Blain of Mint Partners

The Great Crash of 2018? Look to the bond markets to trigger Mayhem!

I had the impression the markets had pretty much battened down for rest of 2017 – keen to protect this year’s gains. Wrong again. It seems there is another up-step. After the People’s Bank of China dropped $47 bln of money into its financial system (where bond yields have risen dramatically amid growing signs of wobble), the game’s afoot once more. The result is global stocks bound upwards. Again. It suggest Central Banks have little to worry about in 2018 – if markets get fraxious, just bung a load of money at them.

Personally, I’m not convinced how the tau of monetary market distortion is a good thing? Markets have become like Pavlov’s dog: ring the easy money bell, and markets salivate to the upside.

Of course, stock markets don’t matter.

The truth is in bond markets. And that’s where I’m looking for the dam to break. The great crash of 2018 is going to start in the deeper, darker depths of the Credit Market.

I’ve already expressed my doubts about the long-term stability of certain sectors – like how covenants have been compromised in high-yield even as spreads have compressed to record tights over Treasuries, about busted European regions trying to pass themselves off as Sovereign States (no I don’t mean the Catalans, I mean Italy!), and how the bond market became increasingly less discerning on risk in its insatiable hunt for yield. Chuck all of these in a mixing bowl and the result is a massive Kerrang as the gears of finance explode!

Well.. maybe..

I’m convinced bond markets are the REAL bubble we should be watching. 

I’m convinced it’s going to start in High Yield.. so let’s start by talking about Collateralised Loan Obligations – the CLO market. Did you know that since the Global Financial Crisis (GFC) in 2008 only 20 out of 1392 deals have seen their riskiest tranches default? (I pinched the numbers from a Bloomberg article.) When I quoted these numbers in the office everyone was surprised.. Surely losses were greater?

Of course not.

It wasn’t just banks that benefitted from Too-Big-To-Fail. (TBTF) Most CLOs did very well. In 2008 smart credit funds realised they would benefit on the back of TBTF and did exceeding well out buying cheap CLOs from panicked sellers. As the GFC unfolded in the wake of Lehman’s default, the global financial authorities pulled out the stops to stop contagion. Banks were unwilling to realise further losses, interest rates plummeted, meaning the highly levered companies issuing the debt backing CLOs survived and were better able to repay their existing debt.

The 2008 GFC was about consumer debt – triggered by mortgages. We still have consumer debt crisis problems ahead (in credit cards, autos and student loans). There is also the fact Consumers have suffered most these past 10-yrs as massive income inequality has left them paid less and paying more for everything – which is most definitely going to come back and haunt markets at some point.

But, I do think the next Financial Crisis is likely to be in Corporate debt, and will be an credit market analogue to the consumer debt crisis of 2008. The Hi-yield market is the likely source - as markets recovered banks started lending again, and low rates forced investors out the credit-risk curve to buy returns. The funds who used to buy nothing but AAAs are now buying speculative single B names. Such is the demand for assets, these companies have been able to lever up and refinance, increase leverage and refinance further, at ever faster rates.

It’s been exacerbated by private equity fuelling returns through debt.  As demand has increased exponentially, borrowers have been able to slash Covenants, making it easier and simpler for over-indebted companies to raise more and more dosh.

Where does it end?

As rates rise we’re going to see the “Toys’R’us” moment repeated on a grand scale. The rise of and fall of Zombie companies that simply can’t meet debt payments is bound to contage not just the rest of the credit market, but also stocks. 

More immediately, the realisation a crisis is coming feels very similar to June 2007 when the first mortgage backed funds in the US started to wobble. (The first few pebbles rolling down the hill before the landslide?) It explains why we’re seeing the highly levered sector of the Junk bond markets struggle, and companies correlated to struggling highly levered consumers (such as health and telecoms) also in trouble.

Basically, the very little is really fixed since the 2008 financial crisis. 10-years later, here we are with the next bubble about to burst. Corporate debt watch out.

Which leads us to the UK Housing Sector…

A few days I commented on how UK house prices have risen 50% over the last 5-years – a period which has seen incomes stagnate. The result is its practically impossible for anyone on a normal salary to even contemplate ever affording their own house – a very good article in the FT yesterday saw the author explain he’d have to save 20% of his gross income for 60 years to be able to put down a deposit on the bed-sit he lives in!

In short, the great myth of the Thatcher generation is dead. The dream of home ownership in the UK won’t happen for our children’s generation.. They will be forced to rent, and that’s a very expensive market here in London. At the moment a mortgage is far cheaper than renting – but as rates rise that will correct a little. 

Somehow we have to create decent rental accommodation at a cost comparable or below mortgages. After all, if you own a house you save money on accommodation, and you get all the upside from appreciation of the asset. Historically, housing has been a better performing asset to own than even stocks - so perhaps there is even a tax angle there, but one no sane politician would date to broach. 

To make it happen we need to encourage public and private landlords with the where-with-all to build new quality rentals - and surprisingly this may be possible under current government polices announced yesterday such as privatising the Housing Associations. As this point regular readers will be in shock – “Blain praising the government? Pass the smelling salts”!

Insurance and pension funds will fund the assets - they know house are literally "safe as houses"!  There is a clear role for Housing Associations to become even more important quality providers of rental/social accommodation.

The big risk is some political fool will decide to enhance their electoral prospects with some ill-conceived "right-to-buy" policy which will simply fuel expectations, drive up consumer borrowing, and fuel a boom market once more putting property out of reach for the masses. 

Meanwhile, I suppose we should be worrying about the fact Merkel still can’t put a government together, the fact it’s now pay to get out of jail in Saudi, and all the other noise. Will anyone be listening to Theresa Maybe in Brussels today?

Comments

UndergroundPost Justin Case Fri, 11/17/2017 - 07:11 Permalink

"Personally, I’m not convinced how the tau of monetary market distortion is a good thing? Markets have become like Pavlov’s dog: ring the easy money bell, and markets salivate to the upside."More like Heroine dens: spread out the easy juice, supply low cost - or even free - needles accounts for easy injection, or sophisticated hookah derivative vehicles for the more sophisticated, and markets soar to the dreamy upside...until they crash

In reply to by Justin Case

marathonman NoDebt Fri, 11/17/2017 - 10:56 Permalink

Not to mention all the rehypothecated new credit they created based on those assets because they’re insured and safe and all. The global Ponzi is truly off the rails.

Go to macrovision.com and listen to the 4 part Jeffrey Shnider EuroDollar university series podcasts. Freaking dynamite to help your understanding of global finance. You’re welcome.

In reply to by NoDebt

MusicIsYou HenryKissinger… Fri, 11/17/2017 - 09:38 Permalink

Will the great crash start in 2018? All I know is that the mega rich are so inept to the point that the Federal Reserve had to give them a guaranteed Universal Basic Income. So when I hear rich people telling me what the charts and graphs mean, I dismiss it because they don't know what they're doing themselves or the Fed would not have had to give them free money golden parachutes.

In reply to by HenryKissinger…

reload Fri, 11/17/2017 - 06:26 Permalink

I was hearing. earlier in the week, from an old freind who works in Geneva - about some of the credit instuments his firm trades in.Probably fairly mainstream to some - but news to me, and I am not particularly naive financially. Namely Bank Bonds that are `Tier 1 alternatives` - with the slang name CoCo`s. The volume of these things is vast - and the prices have risen on a bitcoin type tragectory this year. One fund he sells to had 500M worth last year - they now sit at 12B !! -- guess where the money has come from ? almost certainly our old freinds the primary dealers!These things can go no bid - in a nanosecond. There are no exchange implemented circuit breakers - or the like. Earlier in the year, when there was a slight panic about a couple of hungarian banks `their CoCo`s which had traded at 114 on the friday - were 64 offered on the monday.I have a suspicion that one of the drivers behind so much issuance amongst banks is that Mr Draghi has drained so much paper from the market that the system needs something to replace it with.Plenty of oportunity for unforseen outcomes.  

NoDebt JohnGaltUk Fri, 11/17/2017 - 06:50 Permalink

First proposed after the junk bond crisis in the late 80s.  Rehashed after the 2008 GFC.  Bonds with a forced conversion to equity based on some capital ratio or share price or some such "event".  Great for auto-bailing a bank that gets in trouble.  Not so great for existing shareholders of the bank who would be severely diluted overnight. 

In reply to by JohnGaltUk

turnoffthewater Fri, 11/17/2017 - 06:28 Permalink

Bonds vs fiat, the greatest hegemony ever. Paper versus paper = unstainable as history has proven
Bitcoin or crypto's, the great escape with Steve McQueen=until govt's around the world pursue the owners with DnD
Tangibles items realestate, copper, good to go
Solution=diversity

junction Fri, 11/17/2017 - 06:38 Permalink

An indicator of the impending market collapse in 2008 was the bank run on the Northern Rock Bank in the UK.  The BBC's long running series "Money Programme" dealt with the situation in its 9 November 2007 episode.  A few months after this episode aired, the BBC canceled the "Money Programme" from its  regular line-up.  Originally titled "The Money Programme", this show had been on the BBC since 1966.  After the Northern Rock episode, Money Programme's days were numbered.  ---Run on the Bank: Northern Crock Series featuring stories from the world of business and work. In the first of a two-parter about high street banks, Libby Potter investigates the first run on a British bank for over a century. Northern Rock was once the darling of the City. Now it's a crock struggling for survival as potential buyers circle. How did a regional building society grow to be the fifth largest bank in just a few years - and then fall apart spectacularly in a few days?

JohnGaltUk junction Fri, 11/17/2017 - 06:49 Permalink

Funny you should mention that. At 5.30am Monday to Friday they had a programme called Business Report with Sally Bandock, it is now called The Briefing. I had been watching since 2000 and in its hayday was very informative but in the last five years it has become crap and I stopped watching regularly because they were not reporting anything about the state of the Italian Banks. They did not report the fact that the Hungarian Govt confiscated every citizens private pensions, they did not report that France had banned the purchase of gold for home delivery. The were filtering out any negative news about the EU.Scum.

In reply to by junction

b-sugar Fri, 11/17/2017 - 06:34 Permalink

if bonds crash, stock will go higher. this is insane stupidity i'm reading, are you still using 00' galsses to see this world, it's another spectrum folks

Ivan de beers Fri, 11/17/2017 - 06:36 Permalink

The Great crash of 2018 will become the great crash of 2019 and then 2020 and so on. Its never coming, if you missed out on the bitcoin lotto then you missed out. There will be no gold lotto, not in our lifetime.

Memedada Ivan de beers Fri, 11/17/2017 - 06:53 Permalink

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You are right, the monetary-base (fiat-base) will just continue its exponential rise to infinity with no consequences. We will all be billionaires!/s

In reply to by Ivan de beers

JohnGaltUk Fri, 11/17/2017 - 06:37 Permalink

It will not only be corp bonds I think we are going to see a whole series of sovereign defaults in western Europe and spread like dominos.As Madcow said about Trump, this will be the end of life as we know it.

Cry Baby Moe Fri, 11/17/2017 - 06:43 Permalink

The truth comes out. Everyone! The world as we know it is ending. The ZH has spoken. Remember, you saw it here first. please repeat this message by every other post by the ZH Prophets of DOOM for the next 50 years until the crash happens...

buzzsaw99 Fri, 11/17/2017 - 06:48 Permalink

As rates rise we’re going to see the......but as rates rise that will correct a little.   alas, all these articles have the same faulty premise.

To Hell In A H… Fri, 11/17/2017 - 07:04 Permalink

I'm just going to call a spade, a spade. On current affairs and geopolitical issues, ZH, is ahead of the curve, but when it comes to economics and the extrapolation of future economic events, ZH is completely hit and fucking miss. Economics is not an exact science and sometimes I believe ZH, does not reflect this fact in their analysis. The system is completely rigged. The banksters called themselves "master of the universe" and I once thought "The markets will show you fuckers", but I was wrong. The banksters ARE THE FUCKING MARKET and these bastards hold all the aces.With QE now the norm, these guys have access to a line of zero interest credit previously unimaginable. What do we know?

  • The banks are buyers of first and last resort.
  • The banks are buying up corporate bonds.
  • The banks are buying their own government debt

While the markets and all the MSM economists are in a daydream and wont ask the hard questions, nobody is questioning who is buying bonds. Until liquidity dries up, nothing will change. While QE is authorised nothing will change. Printing money only matters when Zimbabwe, Argentina, Venezuela, or those countries outside of  big club do it. When we do it, it's just another tool to be utilised, such is the hypocrisy and the rigging of the system. Until a semblance of sound money is reintroduced, magic tricks and contradictions do not matter.The DOW at record highs, yet dividends are shrinking. What economic theory predicts this?

buzzsaw99 To Hell In A H… Fri, 11/17/2017 - 07:13 Permalink

i'd just like to know how every.  single.  fucking.  author.  reaches the same.  fucking.  conclusion.  every.  fucking.  time?  and the worst thing, they won't even entertain the possibility that they.  are.  all.  fucking.  totally.  wrong!sure, there will be a few speed bumps along the way, but those are manufactured speed bumps.  you are all getting worked up about a market that has been fucking dead for years.  dead.  do you hear me, dead.  write a piece where everything stays the same, the usa 10Y is at 0.65% in ten years and the fed makes sure that nobody of any consequence ever goes bankrupt, the pension funds don't lose 60% of their money, and things never change because they never fucking change!

In reply to by To Hell In A H…