Is This the Canary in the Economic Coalmine?

I don't normally tell people to read my stuff but, in this case, it's important. Particularly if you have even a penny invested in stocks, bonds or ETFs (electronically traded funds). Whether as stand-alone investments outside of a 401k or Keogh or, particularly, if you are invested in a pre-tax payroll investment account such as a 401k. If you think what I say here is interesting, share it with others you know because this could be the canary in the coalmine for another financial / economic meltdown.

Late last week both Stone Lion Capital Partners and Third Avenue "gated" junk bond funds. That means that if you had money invested in junk bond funds at either of these firms, or with any others that have been 'gated', you cannot redeem your holdings. The fund is closed with your money inside - the gate has come down separating investors from their investments and there is no recourse. That money is, for all intents and purposes, gone. News of these funds is all over the place in the news - I've posted just three links, and here's an excerpt from the CNN report (link below): 

"Opportunity in the junk bond crisis: Junk bond ETFs get hit hard in the wake of Third Avenue Management's decision to liquidate its junk bond fund and activist investor Carl Icahn weighed in on this move. Greg Peters from Prudential joins to discuss.

 

Hedge fund Stone Lion suspended redemptions in its oldest fund Friday, the latest pain in the high-yield debt market, The Wall Street Journal reported.

"The firm said its $400 million portfolio fund received "substantial redemption requests," according to the paper. Stone Lion says it manages around $1.3 billion, and focuses on distressed debt. Stone Lion's move follows steps taken by Third Avenue Management, which on Thursday said it would stop withdrawals from a high-yield bond fund that it is attempting to liquidate. The value of many distressed and risky investments has plummeted recently."

http://money.cnn.com/2015/12/11/investing/junk-bond-fund-blows-up-third-avenue/

http://www.marketwatch.com/story/now-stone-lion-capital-suspends-redemptions-as-junk-bond-market-fears-accelerate-2015-12-11

http://investmentresearchdynamics.com/second-warning-get-out-of-your-bond-fund-before-its-gated/

As I do to make sure that what I present here is accurate, I went out to the larger web and Googled "Junk Bond Market News". That resulted in a list of pretty scary headlines if you own mutual funds - most of which also include investments in bond funds because bond funds are generally seen as being "safer" and less volatile than stock holdings.

Because of the attractiveness of return on investment of junk bonds, a lot of brokers buy some to add to their mix of more stable offerings. If a lousy bond or stock priced at $1.50 or $2.00 per share jumps 50 basis points, that's a significant ROI.

http://www.wsj.com/articles/junk-bond-selloff-intensifies-after-funds-demise-1449857705

The opening paragraph in the article linked above says:

"U.S. junk bonds posted their steepest decline since 2011, intensifying fears that a six-year bull market in stocks and other risky assets is nearing an end."

Based on these articles, and other articles I found, the junk bond market - those investments that are the riskiest of the risky - is unraveling. If this follows past patterns - like the financial crisis of 2007-2008 which led to the "deepest recession since the Great Depression" - we are gonna be in a world of economic hurt sometime next year or in 2017.

Googling "junk bond 2007" brings up this, among other articles:

http://www.investopedia.com/ask/answers/041515/what-role-did-junk-bonds-play-financial-crisis-200708.asp

More worrying is this article from MarketWatch from last Friday:

http://www.marketwatch.com/story/high-yield-debt-meltdown-is-so-similar-to-2007-gundlach-says-2015-12-11

So, what does it all mean? It may well mean that the house of cards we've been seeing in the financial markets - the Dow Jones Index, the S&P 500, etc. - is starting a harmonic breakdown as Gundlach says in this article:

"“People are too long credit and the credit is melting down and the stock market is whistling through the graveyard. It is so similar to 2007, it’s scary,” said Gundlach, who oversees $80 billion at the Los Angeles-based DoubleLine Capital."

But what about the NYSE, the Dow Jones? The stock market is up above 17,000 points!

Back in 1987, on Black Monday, world financial markets "crashed", losing twenty percent of their value. This was in the days before the automatic trading stops. In fact, this was the root cause for the development of the automatic trading stops. Now, if a single stock or the entire market drops a certain percentage, trading is halted in that stock or in that market. In 1987 it took months to recover from that drop. You can see from this chart (yes, I know charts aren't fun or sexy, but they are telling) that a recovery hadn't even begun three months later:

Attribution: "Black Monday Dow Jones" by Autopilot - Own work by uploader; DJIA values from http://www.cs.princeton.edu/introcs/data/DJIA.csv. Licensed under CC BY-SA 3.0 via Commons - https://commons.wikimedia.org/wiki/File:Black_Monday_Dow_Jones.svg#/media/File:Black_Monday_Dow_Jones.svg

https://en.wikipedia.org/wiki/Black_Monday_%281987%29

Today, this drop would have been reversed in a matter of just a couple of days, at most, because of U.S. Federal Reserve intervention - POMO - but I'll get to that in a minute.

Starting last week, ahead of the Federal Reserve's meeting next week to pronounce whether interest rates are going up, going to negative or staying where they are, people started moving their money:

Equity funds saw $6.4 billion in outflows over the past week while market participants pulled $6.1 billion from fixed income, according to BofAML. Yield plays suffered in particular, with high-yield funds losing $3.8 billion — the most in 15 weeks, while bank loans and master limited partnerships also sustained losses.

http://www.cnbc.com/2015/12/11/investors-flock-to-cash-ahead-of-fed-meeting.html  

And those high-yield funds mentioned there are the junk bond funds - like Stone Lion and Third Avenue.

So with equity funds - stocks - seeing a $6.4 billion outflow last week, the markets are starting to roll over - and, according to the guys I've been reading, it's only going to get worse.

Following the 2007-2008 financial meltdown, the U.S. Federal Reserve, Congress and the Treasury department instituted "fail safes" to protect the Too Big To Fail Banks. Remember those financial institutions the US taxpayer bailed out? Yeah - those guys. At the G20 a couple of years ago everyone in attendance all signed off on "Bail-Ins" in case the banking and investment industry goes back down the 2007-2008 road.

A bail-in is simply a nice way of saying "stealing". In a bail-in, the banks, by law, can take money from investor's accounts in order to keep their operation going. It was done in Cypress a few years back, and it's been signed off on by the Central Banks (including the Federal Reserve in the US) around the world.

The US Federal Reserve in collusion with the US Treasury Department also instituted Permanent Open Market Operations (POMO) which is convoluted talk for monetary intervention in the financial markets if things look shaky. Here's the definition of POMO:

DEFINITION of 'Permanent Open Market Operations - POMO' When the Federal Reserve buys or sells securities outright in order to permanently add or drain the reserves available to the U.S. banking system.

So what's the problem? Well - it leads to a false idea about the economic health of America. We are being spoon-fed a bright and glowing picture that is based on false data.

If the securities markets - stocks, bonds, banks, anything monetary - shows a less than rosy picture, the Federal Reserve does an asset swap to shore it up and make it look less sickly. The following excerpt is from a 2010 article (emphasis added in places with bold text), and the Fed's continued interjections into the financial marketplace have accelerated since then, inflating the DJIA far higher than it would be were the numbers real.

"For the period of POMO’s from 2005-2007 there were 50 operations and the market advanced a grand total of +0.35% on these days.  Since the market collapse, however, there have been 155 operations and the market has advanced a total of +26.95% on these days. So, the outsized returns could merely be a function of coinciding with one of the greatest bull markets in history.

"What’s so interesting about all of this is the real world impact, however.  These operations don’t alter net private sector financial assets.  Therefore, it’s really just asset shuffling.  The Fed is not printing new money when it conducts these operations.  They’re simply asset swaps.  They don’t add to the private sector’s income, they don’t create jobs, they don’t make the economy better off (aside from a highly debatable and marginal interest rate effect).  There is, however, an obvious argument that there is a high correlation between market response and POMOs.  So while there is no reason to believe that these operations actually make us all better off there is considerable evidence supporting the idea that these operations correlate with periods of assets being “higher than they otherwise would be” – in other words, assets tend to be disconnected from their fundamentals during these Fed operations.

"I’ll be honest with the reader.  When I ran this data I was really hoping that I would find evidence showing that the POMOs have no impact on market direction.  The conclusion is unsettling for obvious reasons.  And while this might be nothing more than a case of datamining, the evidence is convincing that the Federal Reserve is helping to boost equity prices without creating an equally positive change in SUSTAINABLE economic growth.  I’m not a conspiracy theorist, but when I’ve got the Manager of the System Open Market Account for the Federal Open Market Committee telling me that he wants to keep “prices higher than they otherwise would be” combined with this evidence it makes it very hard to believe that the Fed isn’t attempting to outdo Bernie Madoff."

http://www.businessinsider.com/a-case-study-does-the-feds-permanent-open-market-operations-actually-lift-stock-prices-2010-10

In other words, ladies and gentlemen, the US government, in collusion with the US Federal Reserve, is running a Ponzi scheme and this Ponzi scheme, if the shakiness starting in the bond market is anything to go by as it was pre-2008 economic collapse, is about to come down.

If this 'gating' of junk bonds is the dying canary in the goldmine and if the equity markets do collapse, we will be in for a really wild ride. There will more than likely be another financial collapse. Unemployment will resurge to something much higher than the purported (and purely BS) 5.1% being touted by our government*. Welcome to the Third World, America!

http://www.cnbc.com/2015/10/02/chart-whats-the-real-unemployment-rate.html

So, call your broker and put at least some of whatever holdings you have into the safest thing you can find. Money market is marginally safe, liquidation is safer because our financial institutions have the option of bailing-in the monies they have on their books if they get too tightly squeezed. Then hold onto your hat because I'll wager that no matter what happens, those paper assets are gonna take a ginormous hit, and there's nothing you can do about it.

Good luck!

Philippa

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