IT’S JANUARY IN the bond markets, so buyers must surely be lining up waiting for all that juicy new issuance. But are they?
Well, yes and no. The days when January was the month where new money from real investors came pouring into the markets making everybody rich (other than perhaps those investors) have long passed and it has become something of a technical battlefield.
For years the year-end/new year dynamics were dominated by one key feature: that the investment banks – that’s the Goldmans, Salomons, Lehmans, Morgan Stanleys, Bear Stearns and so on – all had their year-end on November 30. That meant that they could stand around in December scooping up cheap assets which the commercial banks had to shed by December 31, only to sell them back again at a juicy profit in January.
This may have been an expensive exercise for some, but it at least guaranteed some market liquidity in December and again in January. Sure, the Canadian banks still use November 30 as financial year-end and they have taken up some of the slack, but they have always been quite conservative in terms of credit risk, so they can do little more than shine a light into a very small corner of the room.
During the 2008 financial crisis, the SEC was happy to see the investment banks pushed into taking out full banking licences in order to gain access to emergency funding at the Federal Reserve’s discount window, thus submitting themselves to the full force of banking regulation.
The shift in market dynamics has turned January into something of a slug-fest
This did, however, force them to move their year-end from November to December, thus removing the levelling effect of the staggered year-ends. We now find ourselves with the entire Street – less Jefferies – trying to do the same thing at the same time. The past week has displayed this phenomenon for all to see, as – although markets were initially under huge pressure – cash bonds outperformed the indices pretty much across the entire credit spectrum. More buyers than sellers in a falling market which was thought to have more sellers than buyers? Try to work that one out.
It doesn’t really matter how much traders or investors like or don’t like markets, both have to be core long, for that is their purpose in life and what they are paid to be.
The shift in market dynamics that the licensing of the investment banks brought with it has turned January into something of a slug-fest. As issuance begins to pick up, things relax in the secondary markets but the strong bid is often mistaken for deep real-money activity. There is of course a cash overhang from a more or less dormant December and this backlog has to be put to work, but it is delayed money and not new money. That will not begin to filter through until the third or fourth week in January, by which time the Street is chasing real-money buyers and real-money buyers are chasing the Street.
By the second or third week in February it becomes evident that there is more smoke and more mirrors on show than in Francisco Scaramanga’s island hideout. February 15 is always a good date to begin thinking of buying a few puts or selling some payers on credit.
I’M NOT ALONE in bemoaning the absence of the November year-enders. I dined last week with a seasoned trader from one of the major US money managers who, quite unprompted, commented on how significantly this apparently small alteration in the banking landscape has affected the business environment. The flapping of a butterfly’s wings? Not only has it hit market liquidity, it has also increased the frictional costs of managing money – and if it does that, it feeds straight back into Joe Sixpack’s investment returns, and is it not he who is supposed to be protected?
I keep coming back to my plea to the regulators to begin writing rules that work for the players on the pitch and not only for the spectators in the stands. I fear that we have still not reached the inflection point where it is acknowledged that most of the new rules are still aimed at immunising the authorities from the accusation of being asleep on the job again should something horrid happen.
YET, YOU CAN’T keep a good man down. Despite the events in Paris which not so long ago would have had investors running for cover, markets put on their game face and bought the living daylights out of everything that moved. In fact, the catastrophic losses of the first three trading days of the year were more or less reversed in the following two.
That kind of volatility probably says more about the lamentable state of liquidity than it does about anything else, but it also confirms that nearly all fundamental analytics go out of the window when players – whether that is the Street, as is the case in the first week of January, or real money – panic about being left behind.
Interest rates may be at all-time lows, curves may be flat as pancakes and risks might be hard to price in the uncertain political and economic environment, but there are certain market dynamics which (despite the changes to the investment banks’ year-ends) play out more or less the same way every year. These need to be identified and, if possible, played. I wouldn’t want to suggest that it’s money for old rope, but it’s as close as you’ll ever get.
