Bankruptcy guru Edward Altman sees similarities to 2007 in the credit market today
By Julia LaRoche
Legendary bankruptcy expert Dr. Edward Altman cautioned that this benign credit cycle — characterized by low default rates, low yields, low spreads, and lots of liquidity — could come to an abrupt end.
“It’s been a terrific market for investors for quite a long time and if anything is concerning it’s that we now are more than eight years into a benign credit cycle,” Altman, a professor at NYU Stern School of Business, told Yahoo Finance. “We’ve never had such a long benign cycle. And just that one little fact is something that we should be concerned about because if it comes to one and it could come to an end very dramatically.”
Altman, the creator of the financial-distress sniffing Altman Z-Score, warned in mid-2007 of a “Great Credit Bubble” and that there was going to be trouble in the market. He predicted that a meltdown would stem from corporate defaults. While the primary culprit of the financial crisis turned out to be mortgage-backed securities, investors who heeded Altman’s warning nevertheless avoided a lot of grief.
So, how does today’s market compare to the market in 2007.
“There are some similarities, yes, although the situation back in the great financial crisis was pre-meditated by the mortgage-backed securities and we don’t have that problem now,” he said.
Troublingly, Altman sees the reckless behavior of 2007 surfacing again.
“Back in 2007 prior to the crisis in ’08 and ’09, the fundamentals of credit risk of the companies issuing bonds and taking out loans were quite low,” he said. “And the similarity that I see now between 2007 and 2016 is very similar fundamentals, quite a bit high risk and it doesn’t seem to bother the market because it’s the only game in town in terms of getting yield greater than what you can get for low-risk securities like governments and high-grade corporates.”
In other words, investors aren’t buying junk bonds just because the risk-reward balance is favorable. They’re buying because the rewards of investing in lower risk bonds just aren’t cutting it anymore.
Altman is perhaps best known for the Z-Score, a formula he created 50 years ago that’s used to predict bankruptcies. Since that time, he noticed that bankruptcies have gotten increasingly bigger.
“[What] I’ve seen over the years is larger and larger companies filing for bankruptcy on a regular basis. On average, in the United States, something like 15 more than $1 billion companies, in terms of liabilities, go bankrupt every year, on average,” Altman said. “This year already it’s 13. Last year, it was almost 40.”
He noted that inflation has something to do with it, but what’s actually happening is companies have been taking advantage of debt and low interest rates like never before, and the corporate debt ratios are way up.
“Speaking about the Z-score, if you compare the average Z-score of companies in 2007 with the average in 2016, which is the last time we looked at it, guess what. The average is actually lower today than it was in 2007, and 2007 was right before the great financial crisis, and of course, in ’08 and ’09 we saw a tremendous increase in corporate bond defaults and loans.”
Low Z-scores are associated with financial distress.
He added: “So the good news is that it’s no worse, but the bad news is, fundamentally, the companies are no better than they were back in 2007 at least by our model.”
At the moment what’s keeping companies from going bankrupt as they did during the financial crisis is the incredible amount of liquidity and low interest rates.
We’ll see how long that lasts.
Bond market is in an ‘epic bubble of colossal proportions,’ says Boockvar
By Brian Price
One of the most crowded trades on Wall Street is about to implode, says one market watcher.
"We're in an epic bubble of colossal proportions," Peter Boockvar, managing director and chief market analyst at The Lindsey Group, said Tuesday on CNBC 's " Futures Now " in reference to the fixed income market.
Global yields have been tumbling to record lows, with many dipping into negative territory. The U.S. 10-year (U.S.: US10Y) hit its lowest level ever this week as traders continue to seek safety in the bond market. Yields move inversely to prices.
However, Boockvar believes that this activity is a ticking time bomb for the global economy. He reasoned that U.S. Treasury yields are being dragged down by negative-yielding debt out of Germany, Japan and Switzerland and misplaced monetary policy, and is therefore skeptical as to how much longer the rally can continue.
"It could be central banks that end this," said Boockvar in regard to upward momentum for bonds. In his recent coverage, he reacted to the newly released FOMC minutes and further questioned the Fed's ability to act effectively.
"They'll call it being 'patient.' Their forecasts are now irrelevant, their communication is now meaningless and their tools to handle whatever might come our way are toothless," noted Boockvar when describing the Fed's ability to address a flattening yield curve.
In Europe, concern for Italy's economy continues to rise as that nation struggles to maintain negative interest rates while simultaneously raising capital for its banking system, which is straddled with mounting debt.
"Maybe Italian banks are telling us that central bankers and their negative interest rate policies are actually destroying the Japanese and European banking system?" asked Boockvar in the CNBC interview.
He reasoned that Bank of Japan Governor Haruhiko Kuroda and European Central Bank President Mario Draghi could take a look at what's happening in Italy and decide that their respective monetary policies are the wrong course of action. Ultimately, Boockvar warned of the fallout that could occur if multiple nations opt to end what he referred to as a "negative deposit rate regime."
"Even if they put it back to zero, imagine the carnage, at least in the short-term bond markets," concluded Boockvar.
On this page:
Crash that may send Dow down...17,000 points
Bond market is in an ‘epic bubble of colossal proportions,’ says Boockvar
Crash that may send Dow down...17,000 points
By Stephanie Landsman
He's a market watcher known for making bold calls spanning decades. Now, Harry Dent is arguing that the Trump rally is setting investors up for an inevitable stock market crash.
Investors have embraced the prospect of President-elect Donald Trump's victory by sending stocks on a tear to new record highs. Dent, however, thinks there's trouble brewing.
"I think this is going to be a stock market peak of a lifetime followed by a crash very similar to the early 1930s. This happens once in a lifetime," Dent Research Founder Harry Dent recently told CNBC's " Futures Now ."
He added: "I think this is the last rally in this bull market."
Dent may be calling for the rally's last hurrah, but he's also forecasting another ten to 20-percent jump for the Dow over the next few months.
Since Trump won the presidential election, the Dow (Dow Jones Global Indexes: .DJI) is up eight percent and has closed in record high territory 14 times. Financials (NYSE Arca: XLF) have soared 19 percent, and 10-year treasury yields (U.S.:US10Y) have been rallying— they're now at 2.47 percent.
"The markets are assuming that he is going to create three to four percent growth on a sustainable basis," said Dent. "It is demographically impossible.... When the markets figure this out, they are going to crash."
Dent makes the case that the U.S. workforce will see negative growth, estimating that the population will grow just over a quarter percent over the next 50 years. He also points to rock bottom productivity that not even tax cuts can solve in the immediate term.
"You can't have stocks keep going up at this rate when earnings are going nowhere," said Dent. ""I think it [Dow] is going to end up between 3000 and 5000 a couple years from now."
Dent, who is also the editor of the "Survive & Prosper" newsletter, says there are other major factors which will spark an 'epic' pullback.
"I think the trigger is people seeing sometime early next year that Donald [Trump] will not be able to do everything that he said, and the economy may be slowing by then," he said. "The biggest trigger, kind of like the subprime crisis in 2008, is going to be Italy. Italy is bankrupt. Its bonds are trading at lower rates than ours which is ridiculous."
Not only could Italy send the European markets into a tailspin, Dent is also particularly worried about China.
The world's second largest economy "has the greatest real estate bubble, an overbuilding bubble, in all of modern history. That's going to blow, " warned Dent.
Yet, he says that this could also be the best time in decades to re-position for huge gains. "In the next few months, investors will have the best opportunity to switch their investment strategies and profit dramatically," he said.
Dent is telling investors to sell their stocks near the top and immediately convert into the highest quality bonds. He recommends 30-year Treasuries and triple-A corporate debt.
Still, "Futures Now" traders Jim Iuorio and Scott Nations challenged Dent on his record, saying his predictions over the last 15 years haven't materialized. They referred two Dent forecasts: The Dow would reach 40,000 in the year 2000, and a depression call from seven years ago.
"I make bold forecasts, and especially with things like [quantitative easing] and massive government intervention — yes, I'm going to miss some things. But, I have the guts to make these bold calls," argued Dent. "We've been right about gold (CEC:Commodities Exchange Centre: @GC.1). We got people out in late April... I think could see $700 in a year or two."
What we have is a debt bubble. The rising debt is the stimulus funding the rally on Wall Street. QE1, QE2, QE3, Operation Twist, bailouts, handouts, and now $85 billion injected into the system every month. Hmm, I wonder if there is a coincidence between enormous debt creation and 43 new highs in the Dow this year?
No, the stock market is not in a bubble. It is reacting normally to new injections of cash and buyers. The debt bubble, however, is a different matter. These things end badly, historically. Eventually, somebody has to pay the Piper.
The stock market is up, while the economy isn't. Since the stock market is supposed to reflect the economy, it looks a bit overvalued.
There is also a good reason for over-valuation: the cheap money policy by the Fed means that there is no money in bonds, so many investors have loaded up on stocks, which drives their price up.
The NASDAQ and Russell 2000 are in bubbles right now. Once the fed starts increasing its interest rate, the stock market will drop like a rock.
David Stockman, former director of the Office of Management and Budget under President Reagan, says America has become addicted to debt and that there’s no way to avoid catastrophe.
David Stockman: I think everybody in this generation, and I’m the leading edge of the baby boom — I was born in 1946 — has benefitted from a 30-year explosion of debt, which created temporary but unsustainable economic prosperity and a financialization of the system through lower, and lower, and lower interest rates that has created massive rewards to speculation but not real investments so I benefitted from it. Almost everyone who has been in the market has benefitted but they didn’t earn it.
David Stockman: No. One of the things I say in my book is we need a wealth tax that on a one-time basis is going to take back at least some small fraction of the great windfall that the upper 1 percent, or 5 percent and pay down the government debt, pay back the federal debt because we can’t put this on the next generation or they’re going to be buried paying taxes.
David Stockman: I wouldn’t do it. I think it’s a very dangerous place to be at the present time. In fact, the stock market today is almost identical to where it was in October 2007 and then there was a $7 trillion crash and before that in March 2000. In other words, the stock market today is identical to where it was 13 years ago and we’ve had two massive crashes in between. The middle class has been invited to come and buy stocks and get sheared like so many sheep. They’ve done it twice and I certainly hope they’re not lured into this again because it’s not sustainable because our economy really is failing. Yes, in the short run it’s recovered, or recreated jobs that existed in 2005. You know, the number of jobs today is the same as it was in 2005.
David Stockman: Yeah, but 0 percent interest rates is crazy. It’s lunacy. The Fed put the overnight rate at zero in December ’08. You know what that does? It doesn’t help Main Street. Main Street has too much debt already. It is simply a bonanza for speculators who can borrow the overnight money and then buy something that they can speculate on.
David Stockman: There was a massive bubble in Japan. Half the real estate value in the world in 1989 was in Japan. It crashed. Real estate in Japan has been declining ever since. It’s one of the great deformations, malinvestments, that’s ever occurred in world history. The stock market in Japan was half the world market and where has the Japan economy gone since the 1990s? Nowhere. They’ve been struggling for two decades in the aftermath of a massive bubble that’s collapsed. They’ve tried to work their way out of it by printing even more money and it hasn’t worked. Now, I’m saying this is what all the central banks are doing. There is no honest interest rate in the world today.
David Stockman: The problem is that you’re creating a system of bubble finance where interest rates are so low that people can speculate. An asset value goes up. You put it up as collateral. You borrow against it. You buy more of the asset. You then take the rising asset. You borrow against it again. This is the nature of what’s going on in the world. This isn’t an excess of real savings. This is an excess of artificial credit that’s being fueled by all the central banks.
David Stockman: Because, you’re in a race to the bottom by all the central banks in the world that are expanding their balance sheets at rates that have never been seen before. This money is not leaving the financial markets. All of the liquidity the Fed has pumped in, this balance sheet has gone from $800 billion to $3.2 trillion in just a few years, all of that liquidity is just circulating through the canyons of Wall Street. A lot of it comes back as excess reserves in the banking system which gets deposited at the Fed. It doesn’t go into credit on Main Street because Main Street is already saturated with debt. But, it does suppress interest rates and it makes gambling highly rewarding. When you put interest rates at zero, you’ll buy anything that’s going up and fund it with zero cost money. You will buy anything with a yield and fund it 98 percent, $0.98 on the dollar with zero cost money. So what this is, is a gambler’s dream. The 1 percent are just laughing all the way to the bank.
David Stockman: I think we’re so addicted to bubble finance at the Fed that they can’t get out of the corner they painted themselves into. I think the Fed is making federal debt so cheap that Congress has no interest, Washington has no incentive to ever face up to our massive fiscal gap that is going to grow, and grow as we go forward in time and so we have a paralyzed system.
David Stockman: Well, a lot of people said in 1999, “Yeah, maybe there’s a little bit of froth out there.” But, you don’t understand this time is different and then within three months, devastating collapse. Remember they called it the “Goldilocks Economy” in late 2007/2008? You had the Chairman of the Council of Economic Advisors saying, “No recession in sight anywhere,” in June. Okay, so no one sees it coming until suddenly there is an event, a black swan, something unexpected or unpredicted that tells everybody that the emperor is naked. You know who is naked? The Fed. They’re running a con game.
via David Stockman: We're Blind to the Debt Bubble | Making Sen$e | PBS NewsHour | PBS.
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