Investors are panicking.
It’s a quieter sort of panic than we saw in 2008. But if you want proof, you only need to look at yesterday’s auction of 30-year US Treasury bonds.
To borrow money over 30 years, markets charged the US government the princely sum of 2.925% a year, a record low.
What does that show? It demonstrates that when investors get scared, they all make a dash for the most familiar, most liquid, most comforting asset on the menu.
The US dollar…
What’s spooked investors?
Two big issues have markets rattled right now, and they’re related. The obvious, headline problem is Europe. Wee Sarky is still gloating away about David Cameron, but the grown-ups in the room have already figured out that Britain is just a distraction. The latest Europe deal was a colossal failure, with or without the UK onboard.
Various countries are now voicing concerns about getting the deal past national parliaments. And even if they did, it wouldn’t matter. The deal itself is nonsense. Angela Merkel maybe hasn’t noticed, but the market already imposes automatic penalties on countries that borrow too much money. That’s why Greek bond yields are in double-digits.
The problem is, what do you do once a country has gone beyond the point of no return? And they still haven’t sorted that out. They haven’t even acknowledged the existence of a point of no return.
So the Europe plan looks doomed to failure. As a result, within the region, money is flowing out of the most doomed countries towards the least doomed ones. And on a global basis, money is flowing out of the region altogether.
Is this the new sub-prime?
The other big issue is the aftershock from the collapse of broker MF Global in October. As you may have read, $1.2bn in client funds is missing. That’s not supposed to happen. The money is meant to be segregated. In other words, if your broker goes bust, it will be inconvenient, but your assets aren’t at risk.
The fact that this money has gone missing calls the whole system into question. Right now, a lot of attention is on the process of ‘rehypothecation’, thanks to a recent Reuters column by Christopher Elias. Similar questions arose when Lehman Brothers went bust, but with lots of other banks exploding at the time, you probably missed that in the hubbub.
I’m not going to go into it in detail here, partly because I’m still joining the dots myself. But here’s a rough outline. ‘Hypothecation’ is a fancy word for secured lending. You pledge assets to a lender as collateral, in exchange for a loan. The lender ‘hypothetically’ controls the asset, because if you default, they get to keep it.
‘Re-hypothecation’ is when the lender then pledges the original collateral to someone else, to make bets of its own. This is perfectly legal. So you have the same asset backing a daisy-chain of bets by different parties.
But what happens if the collateral at the end of the chain goes bad? Like a risk-free eurozone government bond that’s suddenly no longer risk-free? And if one party in the chain goes bust, who now owns those hypothecated assets? You thought you owned them, but so does another guy further down the line.
I started trying to explain this to my wife the other night, and within five seconds she said: “Oh, this is just like sub-prime, isn’t it?” Exactly. Chains of loans, backed by toxic assets, and a complete lack of clarity as to who exactly owns what.
It remains to be seen just how significant this is. But you can see why investors are rattled. If you can’t guarantee that your money and assets are safe within the system, then who can you trust? What assets can you trust? Which companies?
Buy America, sell Europe
One side-effect of the ‘rush for safety’ is that it makes things even worse. As MoneyWeek regular Tim Price always says: “If you’re going to panic, panic early”. By the time everyone else is fleeing an asset, it’s often too late to get out with your net worth intact.
Asian shares are now in bear market territory for the year. The Chinese are intervening to prop the yuan up, rather than trying to keep it down. Gold has tanked as investors sell virtually anything to get hold of dollars.
But of course, there’s always a winner. In this case, it’s the US. Even the US banking system is benefitting from this. Money from US depositors is flooding out of any bank with European connections, reports the FT. It’s being housed with domestic US banks instead, which means they get customer deposits at cheap rates, which is good for their balance sheets.
Now, I’m not keen on the idea of taking the plunge into any banking stock right now. After all, there are plenty of other sectors to choose from – why take the risk? But if you fancy your chances, James Ferguson reckons one US bank is now ‘un-killable’. He wrote about the stock in a recent MoneyWeek magazine cover story – you can read the piece here.
If you’re more conservative, I’d be inclined to buy some high quality US stocks (I mentioned a couple earlier this week) and also UK-listed stocks which are exposed to the US. My colleague David Stevenson looked at stocks that can profit from a rising dollar back in the summer – you can read his piece here: Will the US dollar rise from the dead?
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