Tuesday, February 9, 2016

Are Credit Markets Warning of a Lehman-Style Crisis?

Are Credit Markets Warning of a Lehman-Style Crisis?

Mike Larson | Tuesday, February 9, 2016 at 4:20 pm

Market Roundup
16,014.38 (-12.67)
1,852.21 (-1.23)
4,268.76 (-14.99)
10-YR Yield
1.73% (-0.01)
$1,188.00 (-$9.60)
$30.21 (-$1.43)

Credit. Credit. Credit. That’s where the action is these days (and really, where it has been for the last year). And I’m here to tell you the credit markets look to be pointing toward an increasing chance of a Lehman-style crisis.
Hyperbole? Hardly! Take a look at this chart, which shows the cost of insuring against a default on some of the bonds issued by Deutsche Bank (DB)
The cost of insuring Deutsche Bank debt.
You can see the cost of credit-default-swap protection is exploding. So-called “CDS” contracts act like insurance against bond defaults, and the cost of that insurance surges when investors grow increasingly worried about the ability of a government or corporation to make good on its financial obligations. These are the kinds of moves we’ve only seen twice in the last decade — during the 2007-09 credit crisis and the PIIGS (Portugal, Ireland, Italy, Greece, Spain) debt crisis in 2011-12.
And it sure as heck isn’t just Deutsche Bank. CDS costs are jumping across the board here in the U.S., over in Asia and elsewhere in Europe. It’s just a question of degree. Investment-grade credit spreads are now also widening notably, following in the footsteps of the junk-bond market. Spreads there began blowing out several months ago.
Japanese stocks also plunged more than 5% overnight, the worst decline since June 2013. So many investors are dog-piling into government bonds for safety that more than $7 trillion in sovereign securities are now trading at negative yields. Plus, my personal “Look Out Below” indicator that I wrote about Friday is flashing bright red.
Last but not least: Things are getting so bad that Deutsche Bank had to issue a statement late yesterday saying it can make certain debt payments in the coming two years. That was followed up by a memo to employees today in which co-CEO John Cryan claimed the bank was “rock-solid.” The mere fact the company felt compelled to say things are just peachy tells you they could be anything but.
Are we headed there again?
Me? I am so glad that you’re a reader of Money and Markets (and hopefully a reader of my Safe Money Report, too). I say that because you received early warnings about all of these problems 2,000 Dow points ago, and were given step-by-step guidance on what to do to prepare your portfolio for the carnage we’re seeing now.
But what if you didn’t act yet? And more importantly, what do I see happening next? I’ll be the first to admit markets are oversold in the short term. We could easily see a bounce at any time, particularly if Federal Reserve Chairman Janet Yellen throws the bulls a bone in her Congressional testimony tomorrow.
At the same time, it’s abundantly clear to me that central bankers have lost whatever control of the markets they once had. Investors are taking matters into their own hands because they can see the global economy slumping – and they know the bankers are rapidly running out of bullets.
“Widespread adoption of negative interest rates is making things worse.”
If anything, the increasingly widespread adoption of negative interest rates is making things worse not better. I say that because bank stocks plunged further in Europe and Japan, and credit-market stress rose further, AFTER central banks there cut rates into negative territory.
So I’m advising you … urgently … to follow the bear market playbook I partially shared in September. It’s not too late to protect yourself, nor is it too late to target profits from downside moves in vulnerable stocks.
Do you agree? Are we still early in this bear market process, or are stocks about to reverse course and surge higher? What do you think about the problems at Deutsche Bank and other large financial firms? Is this Lehman Brothers all over again, or are markets panicking unnecessarily? Hit up the comment section and let me and your fellow investors know what you’re thinking.
Our Readers Speak
As for the FANG Stocks, many of you weighed in on them after my column yesterday.
Reader Chuck B. said: “Now that the stocks of FANGs and their brethren are starting to collapse, they are going to find it harder to get the loans that have propped up most of them. In fact, nearly all companies are going to have to learn to survive more on earnings – even as earnings may decline. That doesn’t bode well for the markets for some years to come.”
Reader Mike C. added: “The ‘momentum’ play in stocks appears to be dying an agonizing death. When you think about it, the momentum play was akin to jumping on a train for a free ride, and then simply jumping off when it reached your destination.
“Well today, the train has not only picked up speed, but it is no longer a nice evenly-paced trip until you get to your goal destination. It is now switching tracks unexpectedly, and you are no longer heading toward your original destination. Smart thinkers and smart money will eventually figure out that the ‘free train ride’ strategy has run its course, and a new strategy in needed.”
Finally, Reader Donald L. said: “Agree completely about overvaluation. For the past three years, it has been clear that earnings increases did not support an average market price-to-earnings ratio of 16-plus. There is plenty of blame to go around. But until the earnings situation improves, the market will stagnate or worse.”
Reader Nate N. pointed out that FANG stocks aren’t the market’s only problem. His take: “I’m more concerned about the speculative derivatives market where the big banks are playing Russian roulette with bets they can’t cover when the derivative market implodes. They are betting trillions more than they can ever back up, hoping the feds will come to their rescue. Not this time.”
Speaking of someone coming to the rescue, Reader Anthony G. said central banks are tapped out and won’t be able to plug the holes again in this potential credit crisis. His view: “The systemic risk is extreme. The banks in Europe and government debt are outrageous. The Draghi bluff is about to be called. We will soon see if there is enough ammunition left in his tool box.”
Thanks for sharing your perspectives. I’ve been pointing out cracks behind the scenes in the credit markets for more than a year now – and we’re clearly seeing those problems spill over into stocks now. This is just like what happened during the last two major credit-cycle turns and bear markets. That means protective action isn’t just prudent, it’s absolutely necessary.
Other Developments of the Day
BulletThe global petroleum glut is getting worse, according to the International Energy Agency. The advisory group said OPEC members dumped another 280,000 barrels per day on an already oversupplied market in January, with production increasing in Iran, Saudi Arabia, and Iraq. That should keep downward pressure on prices for the foreseeable future.
BulletIt’s not just European bank debt that’s getting hammered. Yields on peripheral European countries are rising again, with Portuguese 10-year yields hitting a 15-month high. Borrowing costs in other “PIIGS” countries are also rising, while Greece’s benchmark stock index just fell to its lowest level since 1990.
BulletThings got dicey in Hong Kong overnight after police tried to clear food vendors from an area in the city, prompting rioters to throw bricks and bottles and attack police. This week is packed with celebrations to mark the Chinese New Year in Hong Kong and mainland China.
BulletToday is the New Hampshire primary, with voters likely to hand Donald Trump and Bernie Sanders the Republican and Democratic nods, according to polls. But New Hampshire’s voting rules and lousy weather in the region could lead to some surprises when results are released this evening.
What do you think of the latest oil glut news? How about the renewed chaos in Europe’s sovereign-debt market? Are you expecting any surprises in the New Hampshire primary, and if so, what will they be? Let me know in the comment section here.
Until next time,
Mike Larson
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Mike Larson Mike Larson graduated from Boston University with a B.S. degree in Journalism and a B.A. degree in English in 1998, and went to work for Bankrate.com. There, he learned the mortgage and interest rates markets inside and out. Mike then joined Weiss Research in 2001. He is the editor of Safe Money Report. He is often quoted by the Washington Post, Reuters, Dow Jones Newswires, Orlando Sentinel, Palm Beach Post and Sun-Sentinel, and he has appeared on CNN, Bloomberg Television and CNBC.
The investment strategy and opinions expressed in this article are those of the author and do not necessarily reflect those of any other editor at Weiss Research or the company as a whole.

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