Fascinating discussion today via Barron’s Alan Abelson. He looks at som interesting ideas from MacroMavens, who raise some interesting red flags in the Corporate Bond Market:
"STEPHANIE POMBOY, WHOSE scintillating and informative MacroMavens is on our short list of must weekly reads just put out one of her periodic issues devoted to trading tips. Stephanie, by way of brief background, is flat-out bearish on the economy and most markets.
Envisioning the twin drags of higher interest rates and energy prices carrying us into recession, her first theme is what to do when credit problems bubble to the surface. Among other things, she points out, $1 trillion in adjustable-rate mortgages are slated to reset in the next 18 months and no less than half of these will hit subprime borrowers. That’s destined to take a toll, not only on the lenders, but on the poor souls who can’t cough up the extra dough and on discretionary spending generally.
So she recommends shorting subprime lenders and going long consumer-staples stocks, while shorting consumer-discretionary stocks. She’d also buy the stocks of companies that specialize in repossession.
Switching to bonds, she notes that the investment-grade universe "has shriveled to almost nothing." Currently, over two-thirds of the industrial bond market merits junk status, compared to only 3% in 1980. Only seven U.S. companies are rated triple-A credits. The value of the entire Treasury market, $4 trillion, is dwarfed these days, she sighs, by the $5.6 trillion in mortgage-backed securities, $2 trillion in asset-backeds and over $3 trillion in high-yield corporates.
When trouble rears its ugly head and investors bolt from risky stuff into high-quality paper, yields on the latter should, she reasons, dramatically compress. One obvious way to play this is to go long 10-year Treasuries, while shorting junk. Another possibility: Short financials against long positions in a defensive sector like health care.
Risk, Stephanie says, "is to market liquidity what kryptonite is to Superman. Its mere suggestion is enough to cause seizures." As risk returns to its rightful place in the investment firmament, liquidity will beat a sharp retreat and "the tide that once lifted all asset boats will beach them instead."
In such an environment, she avers, "what you don’t own may be at least as important as what you do. The key to survival is to underweight the most notorious liquidity lushes. Most generally this would mean underweighting stocks versus bonds, high-yield versus high-grade, and if the past is prologue, the emerging markets and resource economies versus their developed country counterparts."
Emerging markets, she worries, despite their long-term promise, likely would be roiled by fears of a U.S.-led global slowdown and are apt to be "tossed out with the bathwater." She suggests waiting for the storm to pass or hedge existing long positions by shorting those emerging markets most exposed to the U.S. against those most exposed to China, which has both the motivation and means to keep growth going. Happily, she offers a more direct and simpler approach: Go long the Nikkei, while shorting the S&P. (emphasis added)
I find little in there to disagree with . . . note my prior RM discussion on Japan, here.
UP AND DOWN WALL STREET: All Trick, No Treat
Barron’s, MONDAY, OCTOBER 31, 2005