Risk/Reward Vol 372
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
For the reasons discussed last week (TINA, improved economy and cheap money), I, for one, was not surprised by the record setting week that Mr. Market just experienced. As has been the case often this year, Amazon led the charge. Up nearly 5%% for the week and over 58% year to date, Mr. Bezos' company not only has made him the richest man in the world ($100billion net worth), but also the most feared. Indeed, the specter of Amazon domination in such varied fields as entertainment and drug delivery has spurred a bevy of big time merger talks including ATT/Time Warner, CVS/Aetna and Disney/Fox. The boxes bearing the distinctive Amazon tape that accumulate in our building's mail room and the hours I spend watching Trial and Retribution, Red Oak and Catastrophe are testaments to the power of that juggernaut.
Although I remain generally bullish on the market, I am neither a Pollyanna nor a Jeremiah. One would be foolish not to peer over the horizon in search of that which may disrupt this unprecedented string of upward moves. As I have written in previous editions, today reminds me of sitting in board meetings in 2006 of a company that was heavily reliant upon construction and land development. We sensed that the real estate boom could not last forever. We just did not know when it would end. We created a "canary in the mine shaft" report that we thought would give us visibility on a collapse. It worked, but no report could have predicted the severity of the crash of 2008. As suggested last week, I believe there are some canaries worth watching today. Inflation and monetary policy always merit monitoring, but frankly with central banks so attuned to these I don't see them as the cause of any sudden reversal. But credit risk, that is a different matter.
What do I mean? Remember Lehman Brothers? Back in 2008 it was a major player in the financial world serving as a prime broker and counterparty for several large institutions. In order to boost its own profits, Lehman Brothers bet heavily on the highly illiquid subprime mortgage market. When that market suffered a host of reversals, Lehman found itself in a cash crunch and filed for bankruptcy. This caused a run on various types of credit insurance (swaps, etc.) held by AIG and others. The ensuing game of financial musical chairs froze the credit markets world wide. Central banks were forced to cheapen the cost of and to backstop virtually all credit. Thus began the current era of low interest rates and quantitative easing. We have yet return to anything close to "normal" prompting some to call this era of easy money the "new normal."
But, the new normal has its own risks. With rates at record lows for nearly a decade and with so much money available, investors seeking a return, even conservative ones like insurance companies and pension funds, have been forced into much riskier assets. Equities, junk bonds, emerging country sovereign debt and senior loans have replaced triple A rated government bonds in their portfolios. Indeed, a recent report by the Chicago branch of the Federal Reserve noted that credit conditions are as loose as they have been since 1993---looser than they were in 2006. Small wonder the yield on European junk bonds fell below 2% this week for the first time ever. As the stretch for yield causes money to flow into even riskier investments, the threat of default increases. And it is credit defaults, not disappointing earnings, rate increases or inflation that in my humble opinion will take the oxygen out this market.
It is only prudent that you find your own canary.
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