MorningWord 12/14/15: Nothing To See Here, Please Disperse

by Dan December 14, 2015 9:57 am • Commentary

I’m reading more and more arguments why the recent volatility in high yield debt markets right now is different from what went on with the repackaging of subprime loans a decade ago. (The eventual collapse in said products was the spark that ignited the financial crisis.) While 2008 was the only year since 2002 that the S&P 500 had an annual decline, the seeds for the global risk asset route were planted years before and began to sprout in 2007 with the blow up of some CLOs (collaterized loan obligations) in late Spring. As points out, we’re now seeing similar headlines about mutual funds invested (with considerable leverage) in high yield debt:

This year could be shaping up a whole lot like 2007, with the SPX trading in a fairly tight range, both year’s having an August panic that resulted in a 12% sell off from the prior all time highs, then a re-test of the prior lows within a couple months.

SPX 2007 from Bloomberg
SPX 2007 from Bloomberg

The SPX ultimately closed up 5% in 2007 , at the mid point of a 15% range.  This year the SPX is down 2.25%, down about 6% from its all time highs, also at the mid point of the 2015 range. We obviously have a catalyst this week with the FOMC meeting, and I’d be surprised if we closed here, but the risk is clearly to the downside, because any ground that is made up between now and year end on dovish central bank speak will most likely be given back quickly in the near year.

The decline in 2008 took some time to materialize, as investors put more faith in Public and Central Bank speak as to how the subprime credit problem was contained, and manageable, and shrugged off the failing of Bear Stearns and a scary headlines from mortgage and finance companies:

SPX 2007 - 2008 from Bloomberg
SPX 2007 – 2008 from Bloomberg

Of course it’s always different. The hows and whys of the next SPX correction will be unique in their own way. But the rhetoric from the powers that be will likely be the same.

I have no idea if the stress in the high yield debt markets will be systemic. Just as there were very few in 2007 that thought the subprime situation had the potential to nearly bring down the financial system as we know it, there seems to be a great deal of complacency in the current investment landscape, despite what seems to be no shortage of similarities to crises past.