I haven’t written in a few weeks now (partially because I’m a March Madness fanatic) so today’s post will cover two items that are on my mind this week.
Leveraged Loans
The leveraged loan market is all the craze, as covered in the Wall Street Journal and Financial Times earlier this month.
For those unfamiliar, leveraged loans are new debt typically taken out by companies with an already large amount of existing debt. They’re usually senior in the capital structure but have low ratings (higher risk) so they pay higher yields. Additionally, the rate is often variable (resets quarterly) so the bonds aren’t hit as hard when interest rates rise. The combination of higher yields and the possibility of increased coupon payments if rates rise have created so much demand from investors that yields are now at ridiculously low levels for this type of bond. The average price of the index is now close to 98 cents on the dollar when these typically trade at a much steeper discount to reflect the additional credit risk that the bonds hold (risk of default).
There’s a lot more to story as to why these bonds are being driven higher in price but in my opinion it looks like it’s time to get out. I’ve now completely sold-out of the remaining leveraged loan funds that I had clients in. I can assure you that I’m early on making this move – I always am – but I no longer see value in the market at these prices given the potential default risk at this point in the cycle. Investors continue to pile into higher yielding, higher risk bond funds without understanding how the specific market for each type of security works. Unfortunately I feel like unaware investors are being “pitched” these funds with a total disregard for the risks involved.
Europe
I could go on for a very long time regarding the issues in Europe but I’ll save you the time and summarize: Europe is a ticking time bomb. Get out while you can.
Continue reading if you’re interested in more of the details:
The Eurozone (and Euro currency) is a failed experiment that people have been warning about from the very start. You cannot have a single currency when each government still maintains its own debt. And then your banks are leveraged to the brim with all of their neighbor’s debt as “bank reserves” in a fractional-reserve banking system. What a mess…
The balance continues to shift in the wrong direction, with Germany improving while the southern nations continue to deteriorate. And now we have a precedent where the ECB does not back the debt and will confiscate deposits, leaving investors and depositors at risk (as they should be) but removing the “assumed backing” will put even greater pressure on banks as depositors flee to “stronger” banks/countries. We will continue to see crises and bailouts. At this point, it’s only a question of “who’s next?”
The media tries to underplay the significance of what’s going on in Cyprus. If Cyprus remains in the Eurozone, it will absolutely destroy their economy. They need to abandon the Euro while remaining part of the EU. All the while, the IMF and ECB continue to release statements about this being a “one-time event” and how “confidence should now be restored.” I truly believe this is only the beginning of the end for the Euro.
The Eurozone needs to break-up. We probably won’t see it happen for years, until things get really bad, but that’s what happens when you have an imbalance of power. At this point, the troika and Germany control everything and as long as their exports benefit from a weak Euro, they will try to hold the Eurozone together to the demise of France, Spain, Greece, Italy, etc. who’s economies are getting hammered by austerity and a grossly overvalued currency to what it would be worth if they didn’t use the Euro.
I expect a continued strengthening of the US Dollar Index as the Euro gets crushed but investment returns will be dictated by total capital flows. It will be interesting to track how much capital flows into the US seeking “safety” vs. the other emerging nations that have been outpacing the US, and will tell us whether we’re seeing a global “flight to safety” or just an exit of Europe.
US Dollar Index (6 months) – benefiting lately from a weakening Euro, Yen and Canadian Dollar
Euro vs. US Dollar (6 months) – look out below!
US Dollar vs. Mexican Peso (6 months) – capital continues to flow into Mexico and other emerging nations
US Dollar vs. Thai Baht (6 months) – capital continues to flow into Thailand and other emerging nations
Thanks for following!
Nick