Credit Market "Bubble" May Be At Bursting Point
Keith Hazelton
June 02, 2007
This story by Mark Gilbert of Bloomberg News appeared in the May 18, 2007 edition of The International Herald Tribune (Read complete story here).
LONDON: Calling the turn in the cycle of the credit markets has been a losing strategy in recent years. War, pestilence, leveraged buyouts and the collapse of the U.S. subprime mortgage market have all been unable to derail the rally in corporate debt. As the reasons for concern accumulate, strategists are starting to reach for their bear suits.
"We are growing extremely negative on credit markets, which we see as in a bubble," Tim Bond, head of asset allocation at Barclays Capital in London, wrote this week. "U.S. companies are releveraging aggressively in an attempt to substitute earnings-per-share growth for earnings growth. 2008 should see a fairly savage bear market for credit, a large rise in defaults and an end to easy liquidity conditions."
Dresdner Kleinwort's analysts, led by Willem Sels, the head of credit strategy, in London, scrutinized U.S. earnings growth in the past quarter. They concluded that the average figure of 12.5 percent was misleading because it measured earnings per share and was distorted by stock buybacks. Profit growth for the companies in the Standard & Poor's 500 index is just 9 percent, and 3 percent for all U.S. companies. "With net debt growing at 10 percent, leverage ratios are deteriorating," the Dresdner team wrote in a report this week. "Clearly this is not in line with unchanged credit spreads." (All emphasis mine.)
This week IBM announced it would fund a $12.5 billion share buyback, about 8 percent of outstanding shares, by taking on $11.5 billion in fresh debt. Company executives believe IBM to be underleveraged.
As noted above, annualized profit growth for US companies for Q1 2007 was about 3 percent, and 9 percent for the S & P 500, yet stock market index gains since the beginning of the year exceed 10 percent, all of which has occurred in the last two months of trading.
And hedge funds, on average, are leveraged to the tune of 250 percent of assets. Roughly $1 trillion of hedge fund assets are leveraged with $2.5 trillion of debt, borrowed from banks and brokerages and secured by the hedge funds' assets. 2.5:1 is the average.
Some funds have borrowed $13 for each $1 of assets (not equity), which begins to sound more ominous than Long Term Capital Management which, with leverage of about 1:1 in 1998 ($125 billion in assets and $125 billion borrowed, with net capital of almost $5 billion), saw its market bets go awry in late Spring of 1998, and by September needed the Fed to arrange a big-bank bailout of more than $3.6 billion, avoiding a potentially catastrophic global market meltdown.
Deja vu all over again? Apparently financial markets amnesia is a human condition requiring less than a decade to re-manifest itself if Barclays Capital's Mr. Bond, who expects a much more turbulent 2008, is accurate about a "fairly savage market for credit."
What do I know?
Send me an email. --Keith Hazelton
LONDON: Calling the turn in the cycle of the credit markets has been a losing strategy in recent years. War, pestilence, leveraged buyouts and the collapse of the U.S. subprime mortgage market have all been unable to derail the rally in corporate debt. As the reasons for concern accumulate, strategists are starting to reach for their bear suits.
"We are growing extremely negative on credit markets, which we see as in a bubble," Tim Bond, head of asset allocation at Barclays Capital in London, wrote this week. "U.S. companies are releveraging aggressively in an attempt to substitute earnings-per-share growth for earnings growth. 2008 should see a fairly savage bear market for credit, a large rise in defaults and an end to easy liquidity conditions."
Dresdner Kleinwort's analysts, led by Willem Sels, the head of credit strategy, in London, scrutinized U.S. earnings growth in the past quarter. They concluded that the average figure of 12.5 percent was misleading because it measured earnings per share and was distorted by stock buybacks. Profit growth for the companies in the Standard & Poor's 500 index is just 9 percent, and 3 percent for all U.S. companies. "With net debt growing at 10 percent, leverage ratios are deteriorating," the Dresdner team wrote in a report this week. "Clearly this is not in line with unchanged credit spreads." (All emphasis mine.)
This week IBM announced it would fund a $12.5 billion share buyback, about 8 percent of outstanding shares, by taking on $11.5 billion in fresh debt. Company executives believe IBM to be underleveraged.
As noted above, annualized profit growth for US companies for Q1 2007 was about 3 percent, and 9 percent for the S & P 500, yet stock market index gains since the beginning of the year exceed 10 percent, all of which has occurred in the last two months of trading.
And hedge funds, on average, are leveraged to the tune of 250 percent of assets. Roughly $1 trillion of hedge fund assets are leveraged with $2.5 trillion of debt, borrowed from banks and brokerages and secured by the hedge funds' assets. 2.5:1 is the average.
Some funds have borrowed $13 for each $1 of assets (not equity), which begins to sound more ominous than Long Term Capital Management which, with leverage of about 1:1 in 1998 ($125 billion in assets and $125 billion borrowed, with net capital of almost $5 billion), saw its market bets go awry in late Spring of 1998, and by September needed the Fed to arrange a big-bank bailout of more than $3.6 billion, avoiding a potentially catastrophic global market meltdown.
Deja vu all over again? Apparently financial markets amnesia is a human condition requiring less than a decade to re-manifest itself if Barclays Capital's Mr. Bond, who expects a much more turbulent 2008, is accurate about a "fairly savage market for credit."
What do I know?
Send me an email. --Keith Hazelton
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