Anthony Peters, SwissInvest Strategist
The scary bit wasn’t the way in which Spanish asset prices got slaughtered after the failed five-year bond auction to which simply not enough people turned up – we have even seen German Bund auctions meet with a simple lack of investor enthusiasm – but the way in which the bonds of all the usual periphery suspects got flattened at the same time.
There was no notable reason to knock a point and a half off the Italian 10-year or to trash the Greek secondaries. No, what we saw was a spontaneous outbreak of contagion, a phenomenon which the grand EFSF/ESM upgrade of Copenhagen was supposed to have found the antidote to. Are we back to “Everybody into the pool; everybody out of the pool”?
Away from the obvious though, there is something very spooky going on. During the past few years we have seen an ever-increasing interest in covered bonds which prided themselves on not being as risky as securities from the ABS/RMBS/CMBS complex.
However, the spreads on these securities have declined as once again demand has outstripped supply and in the customary manner of financial markets, investors have begun to seek pick-up through assuming higher risk. If that higher risk can be disguised, all the better. Did they not learn anything in 2008 or have they already forgotten the lessons again?
I have spent a couple of days poking around in the CLO market, my old stamping ground, and I was astonished to see to what extent demand for the product has revived again. Please don’t get me wrong – I make a huge distinction between the classical leveraged loan product, the cashflow CLO, and the ritzy synthetic CDOs which is where by far most of the video nasties of the mid-naughties were to be found.
I am talking of CLOs. CLOs feed on leveraged loans which are the product of leveraged buy-outs which are in turn a function of cheap leverage, the root cause of the hubris in debt markets at the beginning of the last decade and the catalyst in the toxic mix of greedy borrowers, greedy lenders and even more greedy intermediaries which brought on the financial crisis.
Just lipstick on a pig
Somewhat per chance, I attended a little soiree last night at which I was the only debt animal and which was otherwise pretty exclusively populated by private equity folks. As I have been around long enough to remember the era of Drexel Burnham Lambert and Michael Milken, of Jimmy Goldsmith, T Boone Pickens, Meshulam Riklis, Ron Perelman and so on when they were referred to as corporate raiders and were top on the “Wanted – dead or alive” list, I probably also know that private equity has nothing at all to do with equity but everything to do with leverage and debt.
When the private equity and CLO markets were at their respective peaks in 2006–2007, there was always a chicken and egg debate as to whether the demand for CLOs and hence leveraged loans drove the private equity business or the other way around. I sensed last night that even the PE guys themselves knew the answer and one of them (who shall never be named) suggested himself and unprompted that the sector really is just a huge scam which charges – as do many hedge funds – alpha fees for leveraged beta.
Moving to smart offices in Mayfair or on Madison Avenue is just putting lipstick on a pig. The only thing that has changed in the 25 years from 1987 to 2012 is the quality of the PR.
The fact is that the risks involved in the alternative space are only really worth taking when the underlying markets are in a stable condition. The waves which a crisis in core markets generate do not dissipate as they spread but increase – in line with the leverage employed – and just as riskier asset classes are seeing a revival in their fortunes, they risk getting knocked over again.
I am still not comfortable with sovereign risk in Europe and also feel uneasy about the slowing of economic activity in China. On the flip side, I also think that it would be foolish to treat the nascent recovery in the US as no more than a fleeting flap of the butterfly’s wings but believe that it would be equally unwise to unquestioningly expect it to unfold as a stable or even accelerating process.
Nature’s enchantment
As we go away for our respective breaks for Easter of Pesach, we should take the time to reflect on the season message of rebirth. Far more to the point, we should remember that nature enchants us by coming back just the same as it was for the previous seasonal cycle without constantly trying to reinvent itself. Market risk remains very high and beware of anyone who tries to tell you differently.
Alas, it is that time of the week again – albeit a day earlier – and all that remains is for me to wish you and yours a very happy and peaceful Easter or Pesach. May the egg-hunt in the garden take place in the sun and not in the snow – but I am naturally risk-averse and will therefore not be putting money on either. Oh, and as an afterthought – it’s the Augusta Masters this weekend and for once we can watch the final round in the knowledge that we don’t have to be up at “sparrows” again on Monday. How about that!