You don't have to be a pessimist, but it helps.....

Monday 22nd June 2015

 

You don't have to be a pessimist, but it helps.....

 "Sell-off fears cast cloud over bond managers' summer" The FT Weekend, p.17

Sometimes it feels as though we are always looking at Doomsday scenarios. In life, that would make all of us something of a Cassandra and a very poor dinner-party guest. In markets however, it's only common sense. After all, what is Risk Management if it's not examining and protecting against downside dangers ? So let's try this one for size :

"A combination of four main factors could combine to cause a crash in bond markets during the summer."

We've highlighted all these factors before, and they are :

1.  The Greek debt crisis ..... the fear is that contagion could spread firstly into other "peripheral" markets and thence into major ones. The counter-argument is that unlike in 2010 and 2012 the rest of the EU's banking system would be relatively unexposed to a Greek default / Grexit.

2.  US rate rises...... the fear is that because of a poor first quarter, future growth in the US has been underestimated and the Fed will be forced into a series of pre-emptive rate rises that will come as a very unpleasant shock to bond markets. The counter-argument is that Fed Chairwoman Janet Yellen is sounding increasingly doveish, emphasising the "gradual" nature of any rate rises for which the markets will be well prepared (or at least should be!).

3. The bursting of the Chinese asset bubble..... the fear is that China's stock markets, already valuing companies many times higher than any Western student of P/E ratios would even contemplate, must suffer a major setback sooner or later. The counter-argument is that China sets its own rules and new investors from China's expanding middle class are still pouring money into the market.

4, Lack of liquidity...... the fear is that the now constant problem of lack of liquidity (or "depth") in bond markets, in large part a result of the banks withdrawing from their role as market-makers due to new regulation, will be exacerbated by the traditional summer slowdown and therefore price moves will be wildly exaggerated. The counter-argument is that while prices do get distorted by lack of liquidity, they generally rectify themselves fairly quickly.

You can make your own mind up as to how much of a part each of these will play over the summer, and indeed whether they are likely to combine to form a particularly noxious cocktail. But amongst fund managers, some of the big boys see enough of a threat to have made some special arrangements. The likes of BlackRock , Vanguard, Goldman Sachs Asset Management and Aberdeen Asset Management have all increased the size of their credit  lines with friendly banks so that they can easily meet customers' demands for redemptions of their investments in the event of a sell-off in bond markets.

That's not to say all this will come to pass ...... but it might.