Another’s Worries Could Be Your Gains

Here’s a quote to push the fear button:

The credit markets have sharp antennae. They issued early warning alerts four to eight weeks before each episode of stress over the last 20 years, although with several false alarms along the way.

The shake-out in the US junk bond market last week had an ominous feel for traders and may finally mark the top of the post-Lehman boom in corporate credit. The exuberant reach for yield is nearing its limits.

It’s from none other than London Telegraph writer Ambrose Evans-Pritchard. He’s been alluding to a bust for years. But because he does it so eloquently and persuasively, his articles resonate.

And the fact that they contain a large kernel of truth makes them even more persuasive.

Before getting sucked in though, it’s worth breaking his argument down.

The basic premise is that the recent sell-off in low grade corporate credit (junk bonds) is an early warning that the rest of the market is about to follow.

But is it really ‘the top of the post-Lehman boom in corporate credit’? Maybe that’s stretching things a little too far…

Have a look at the chart below. It shows the SPDR Barclays Capital High Yield ETF [AMEX:JNK]. As you can see, it peaked in 2013. The top of the post-Lehman boom in corporate credit was more than four years ago!

SPDR Barclays Capital High Yield ETF 14-11-17

Source: Optuma

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That makes sense given that the US Fed under Ben Bernanke first indicated an end to quantitative easing (QE) in 2013. That 2013 sell-off was the initial ‘taper tantrum’.

From there, the actual wind up of QE and the commodity bear market (especially in oil) ravaged the high yield corporate debt market. It bottomed in early 2016 along with global equity markets.

NASDAQ BIOTECH - S&P 500 Healthcare Index Performance 12/31/12 - 6/22/17 14-11-17

Source: NASDAQ

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Now, as you can see in the chart above, the recent action in the high yield market indicates a potential change in trend. Or more accurately, the bear market in corporate debt that started in 2013/14 could be about to resume — after it enjoyed a counter-trend rally for the better part of two years. 

The point to note is that just because yields are increasing, it doesn’t mean the whole market is going to collapse. However, going back to Evans-Pritchard’s article, it’s clear he’s suggesting that we’re witnessing another lead up to 2008:

Veterans say the market moves over recent days recall the micro-tremors in late 2006: the first nagging concerns about US subprime and a local eruption in Iceland, against a backdrop of eurozone hubris. The party was to run for another half year but the best was over.

I think this obsession with worrying about another 2008-style meltdown is counter-productive. It will cause people to sell in a panic at the bottom of the next correction.

There is no doubt the market needs a decent correction. There is too much optimism built into prices in US stocks, especially in the tech sector.

But that doesn’t mean the system will implode again. The 2008 crisis was built on a global property boom. The banks then securitised the riskiest portion of that debt and it traded as ‘money’ in the global credit markets.

When the market realised that the ‘money’ was actually risky debt and only worth pennies on the dollar, the whole banking system got into trouble and contagion did the rest.

We are simply not at that point now. The fact that there are constant reminders of 2008, and constant worries about it, tells you the market’s mindset is not that far in the clouds.

We might be there in tech, but the global banking system is much healthier than it was in 2006/07.

Look, I don’t know when the next correction will be. Maybe the sell-off in corporate debt is a sign of things to come. But my guess at this point is that the next sell-off will result in a panic in some parts of the market. And this may lead to a buying opportunity.

The best way to outperform over the long term is to take advantage of others’ mistakes. And often, those mistakes are psychological.

As Howard Marks of Oaktree Capital wrote in his book, The Most Important Thing:

The desire for more, the fear of missing out, the tendency to compare against others, the influence of the crowd and the dream of the sure thing — these factors are near universal. Thus they have a profound collective impact on most investors and most markets. The result is mistakes, and those mistakes are frequent, widespread and recurring.   


Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

Official websites and financial e-letters Greg writes for:

Money Morning Australia