Bottom line up front…what are investors to do?
Limit exposure to stocks while this plays out. If you are staying invested in stocks, have a warning system to tell you when the credit market disruptions will spill over into the stock market – like last year.
As you will read below, don’t think all investment grade corporate bonds are safe.
The TSP G fund is basically 100% safe Treasuries. Prime Money Markets Funds are reasonably safe.
The TSP F fund (AGG ETF) holds 40% Treasuries which are safe. And about 25% in government-backed mortgage exposure. The other 35% includes investment grade corporate bonds including international exposure to include sovereign debt.
The TSP F fund comes with default risk on some of its bonds – it’s a very low risk, but it is there. I only recommend holding this fund when you are betting on declining interest rates. Otherwise move to the TSP G fund for safety and its interest rate.
If you hold the AGG ETF in self-managed brokerage accounts be aware it deviated from its index significantly for a few days in 2008. All ETFs can deviate during a liquidity crisis and care should be taken when placing market orders in dislocated markets.
Be aware that the current administration is talking of ending gov’t backing for mortgage entities. This could lead to a repricing of their risk – lower prices. It is something to watch for with the TSP F fund.
Please Join Us for our market warnings and allocation opinions. It could be an interesting fourth quarter like last year.
TSP Investing: Where There’s Smoke…
A financial smoke detector went off in the last month (I’m sure your financial adviser told you about it, right). The financial media provided many excuses like “who knew corporations would have to pay taxes like they do every year at this time surprising the bankers” (never mind they have the lowest tax rates ever).
So we’ve been waiting to see if the Fed could turn that darn smoke detector off. They tried by announcing they are starting money-printing-ops again to buy Treasuries on the open market – $70 billion a month. No luck, it kept going off.
Now guess what, another one is obviously going off since they increased overnight lending in the repo market from $80 billion to $125 billion starting tomorrow.
Notice the “at least” because they just hit $134 billion last night. There is smoke billowing out of the shadow banking system and sorry the Fed will never tell us if it is a fire. They can’t.
Note: The Repo amounts are not cumulative, they are re-occurring loans every night. The issue is they are not going away and getting larger.
What the heck is the repo market?
The repo market is the banker’s bank, an overnight bank, where 24 prime banks lend money to each other and all the other non-prime banks. During the financial crisis, the major wall street players panicked and stopped lending to each other or the medium size banks who depended on these prime banks.
In other words, the financial system seized up and the Fed had to invent tools on the spot to unfreeze it – which included hitting a bunch of key strokes and lavishing the wall street banks and investment companies with all the money they needed to fill in their black holes on their balance sheets.
Guess what, it still did not work in 2008.
They had to force the Financial Account Standards Board (FASB) to change that little rule that required the banks to list their assets at market prices and allow them to record them at full fantasy prices. This stopped the panic (instant on-paper solvency), but not the real insolvency.
Fixing the insolvent financial system required the Fed to re-inflate the bubbles and transfer wealth from savers to the banks & borrowers by manipulating interest rates below inflation. And in Europe to below zero interest rates – as in negative interest rates.
Guess what… it still did not work. They merely transferred the losses and postponed the damage and made it worse in the end – so to speak. No one went to jail and the same damaging culture grew stronger and more powerful.
So here we are again and over the last month, the prime banks have stopped lending enough funds to satisfy all the other banks needs. So the New York Fed (part of our central bank) is lending overnight to meet these needs with money created out-of-thin-air.
And as of tomorrow, they are increasing the amount they lend overnight. In other words, they are providing liquidity to the system every night.
So will it fix the problem?
J.P. Morgan says “NO” and they should know – THEY ARE ONE OF THE PRIMARY BANKS NOT LENDING.
JPMorgan Warns U.S. Money-Market Stress to Get Much Worse 21 October 2019 Yahoo Finance
JPMorgan says it’s not convinced the Fed has resolved the issues in the funding markets, according to a note from analysts led by Joshua Younger in New York. Funding pressures resurfaced last week even after primary dealers, firms approved to trade directly with the Fed, took all of the available overnight liquidity from the central bank and sold it as many T-bills as possible.
“Given the benefits of our newfound perspective, we recommend viewing these moves as highlighting the limitations of the Fed’s chosen solution to their operational issues,” the analysts wrote. “With year-end coming up, this is all likely to get much worse, in our view, before it gets better.”
And confirming that I am not the only conspiracy minded person around, here’s Elizabeth Warren’s 18 October 2019 letter to Treasury Sec Mnuchin asking if Wall Street Banks caused the current crisis to get more free money.
Unfortunately, the next crisis will center in the corporate world and not the banking sector. The word zombie has been used to describe 15% to 40% of the corporate world today, meaning companies that will not be able cover their debt payments if interest rates normalize or we go into a recession.
Lucky those kind bond ratings firms are going easy on some heavily indebted companies [20 October 2019 Wall Street Journal]. You know the rating companies, the same ones that rated subprime mortgages AAA safe.
Kristalina Georgieva, the new head of the International Monetary Fund, was more cautious in a speech earlier this month. In a major downturn, she said, $19 trillion of corporate debt would be at risk of default, nearly 40% of total debt in eight major economies. “This is above the levels seen during the financial crisis,” she said.
To bad, the central bank’s money printing is only for the banks…
Oh wait… the European Central Bank is restarting QE and will be forced to purchase of corporate debt [Bloomberg 21 October 2019] because they are running out of gov’t debt to buy with money created out-of-thin-air. Darn the luck.
The European Central Bank is running low on sovereign bonds to buy — that undermines the credibility of its pledge to keep going until inflation picks up. If inflation takes two years to firm, the ECB could face a shortage of about 60 billion euros ($67 billion) in debt during the next phase of its asset-purchase program.
There’s that bullshit consumer “inflation” excuse again. And since QE does not lead to consumer inflation it might take 10 years and they can buy all the junk corporate debt too.
Of course, borrowing at negative interest rates would make these indebted company’s money! Is that the plan? While draining savers and pension funds that much faster. So you know it’s coming.
Thank goodness, the US stock market is propped up with corporations buying their own stocks back on the open market. No worries there right?
They broke a record in 2018 and may again in 2019. Although its funny the market could only move sideways with over 1.6 trillion dollars in their money burning operations. I wonder who was selling…
Goldman just warned that buybacks are ‘plummeting,’ ending a big source of buying power for the market. And Goldman Sachs should know since they run the largest buyback desk on wall street.
See, Goldman blew a big junk of this year’s buyback authorizations in the first quarter after the market tanked because no one else was buying. The first quarter record rally was a buyback rally. So they have less cash for buybacks during final quarter of this year.
Okay, well at least the Fed restarted buying $60 billion a month (larger than DoD’s budget) in Treasuries this month to help the financial markets in a hurried announcement for some strange reason. And then the Fed Chairman said:
“This is not QE,” Mr. Powell said Tuesday. “In no sense is this QE.”
Yes, QE was creating money out-of-thin-air to buy Treasuries whereas this is creating money out-of-thin-air to buy Treasuries.
Central bank stimulus is distorting financial markets, Bank for International Settlements finds [7 October 2019 Financial Times]
Well duh, that’s the point. Total distortion of the price of money which in turn distorts the price of all financial assets. To bad it did not really help the economy.
Wolf Richter explains why cutting interest rates hurts the economy but props up the financial markets:
Banks stop lending to businesses and customers and start investing in CLOs and other trading investments in search of a spread above borrowing cost. Meanwhile saves lose interest income. It is a lose – lose for the economy, but increases flows into financial assets.
Transferring wealth from savers to debtors and speculators by distorting the financial market’s pricing mechanism. What could go wrong?
We are going to find out at some point in time. Are you ready?
This is not a market crash warning. Not yet anyway. These things take time, but it is coming again in some form.
TSP & Vanguard Smart Investor is for serious and reluctant investors. Join our community today to get market warnings and a better understanding of the investing environment that is based in history and not hype.