Thursday, January 14, 2010

New Normal a Lot Like the Old Normal in Finance

The merry-go-round is turning. Consider the following from today on Bloomberg:

Asset-Backed Debt Revival in Europe Led by Ford, BMW

Jan. 14 (Bloomberg) -- Europe’s asset-backed bond market, dormant for a year, is coming back to life as Bayerische Motoren Werke AG and Ford Motor Co. sell more than 1 billion euros ($1.45 billion) of debt backed by automobile loans and leases.

BMW, the world’s biggest luxury car maker, is selling 742 million euros of bonds backed by German auto leases, said a banker with direct knowledge of the deal. Dearborn, Michigan- based Ford sold 300 million euros of debt tied to car loans on Jan. 8.

The revival in debt backed by consumer and business payments in the auto industry shows improving investor sentiment as Europe emerges from the recession. Yields on company bonds averaged 4.13 percent yesterday in New York, down from 4.37 percent at the start of the year, according to the Bank of America Merrill Lynch Global Broad Market Corporate Index.

“If BMW is successful, it would be a really good indicator for other issuers now monitoring the market,” said Markus Ernst, a credit analyst at UniCredit SpA in Munich. Borrowers testing the waters is “definitely a good sign as it underlines that the market is not drying up,” he said.

Sales of asset-backed bonds in Europe may rise to 50 billion euros this year, from 8 billion euros in 2009, according to Gareth Davies, a debt analyst at JPMorgan Chase & Co. in London. The region’s securitized credit market has been slower to recover than in the U.S. because there’s no equivalent to the Federal Reserve’s Term Asset-Backed Securities Loan Facility, which provides low cost loans to investors buying the bonds.

And this:

Junk Bonds Defy Krugman's Bubble Warning as Loomis Sees Gains

Jan. 14 (Bloomberg) -- The world’s biggest bond investors are dismissing concerns that the high-yield market is a bubble poised to burst after the Federal Reserve’s zero interest-rate policy spurred returns of 57.5 percent last year.

While Nobel Prize-winning economist Paul Krugman and Morgan Stanley’s Stephen Roach see as much as a 40 percent chance for another recession, Loomis Sayles & Co. says debt of the neediest corporate borrowers may be the best bonds to own for 2010.

I was told yesterday that JPMorgan Chase has also increased its exposure to junk bonds.

That this bullishness on junk is occurring while payment-in-kind bond sales have also returned does not mean that it must fail, especially in the short term,.

Meanwhile, Jeremy Grantham and GMO are out with their updated quarterly prediction of prospective real returns from different asset classes. Last I heard, he pegged fair value of the S&P 500 at 880.

On the other hand, GMO does peg U. S. "high quality" equities as producing a 6.8% real return annualized over the next 7 years, far exceeding the 1.3%, 0.5%, and 1.1% expected from U. S. large caps U. S. small caps and U. S. government bonds (duration unspecified, presumably Treasuries) respectively. GMO expects that high quality U. S. equities will outperform large cap, small cap and emerging market equities over this time frame.

All this is occurring while California and New York are out of money in one way or another, and central banks and national governments are creating credit money at record paces because the edifice collapsed. The cynical situation is that high unemployment allows reported price inflation to be low, thus allowing valuation models to flash green in the setting of historically low or record low governmental interest rates.

In a sense, high quality stocks in the modern era, which may have lots of cash flow but generally don't share much with existing shareholders, are similar to junk bonds which after all pay interest (ignoring PIK) and provide a superior claim on corporate assets vs. equity holders. So it may be consistent after all for GMO to be positive on high quality U. S. stocks and Loomis and JPM to be positive on high yield bonds.

In the meantime, the issuance of all this government/central bank debt (credit) is seeping inevitably into the markets and eventually a "boom" will be visible to the public. The financiers who have been bidding up the prices of stocks have not yet interested much of the public in joining in the fun. That may change soon as the public's memory of 2008 fades and it forgets (never understood) the essential corruption that underlay the late 1990s stock bubble and then the massive credit bubble that is now being reblown greater than ever.

Copyright (C) Long Lake LLC 2010


  1. Botox (botulinum toxin), a highly toxic neuro-toxic protein produced by Clostridium Botulinum, is commonly used in cosmetic procedures. Botox is sometimes injected to improve a person’s appearance by removing facial lines and other signs of ageing. The effect is temporary and can have significant side effects.

    The global economy is currently taking the "botox" cure. A flood of money from central banks and governments – "financial botox" - has temporarily covered up unresolved and deep-seated problems.

  2. Nice analogy

    And, administering Botox is very profitable for the practitioner.