What do Toys “R” Us bonds, the populist threat to the European Union, and Turkish external debt have in common?
All were tolerated by market players until, quite suddenly, they weren’t.
Investors seem increasingly prone to flee assets at the first hint of trouble, fueling concern more cracks are appearing in global markets that have been papered over for years by easy money. That climate saw cash simply herded into any investment with a respectable yield. The swift reaction to a twist in Italy’s political drama last week looks like the latest sign.
“The binary ‘all-in/all-out’ behavior, which up until now was relegated to the fringes of the financial markets, has gone mainstream,” Peter Atwater, president of Financial Insyghts, said of the market’s rapid repricing of Italian default risk. “Investors are becoming increasingly manic,” he wrote in a note.
Atwater points out that the surge in the Italian two-year yield resembled the moves in Kobe Steel Ltd. bonds last fall, as well as those seen in debt from Steinhoff International Holdings NV, Venezuela and even Toys “R” Us Inc. The price of the toymaker’s bonds due 2018 plunged September last year to the mid-20 mark when the company filed for bankruptcy protection, down from 96 cents just two weeks earlier.
This global phenomenon is well-known. Economist John Kenneth Galbraith called it the “Bezzle,” referencing the period in which an embezzler has stolen money but the victim doesn’t yet realize it. Perhaps most famously, Warren Buffett put a typical homespun-style on it when he said, “Only when the tide goes out do you discover who has been swimming naked.”
For Matt Maley, equity strategist at Miller Tabak + Co., it’s all about “mal-investments.” He warns that while U.S. stocks have so far weathered the shifting narrative across global markets, they will inevitably feel the impact of monetary tightening as problems spill over.
“It takes a while before the rise in rates starts to impact the markets, but their rise always exposes the mal-investments that have developed during the period of time when rates were going down,” he said. “Last week’s developments were just the newest ones in a progression of ‘cracks’ that have been showing up in the markets since late January.”
Ripple Effect
There are few clearer examples than in emerging markets, where investors have suddenly ended their love-affair with a bevy of higher-yielding assets.
Developing-nation stocks declined for a fourth month in May, the longest run since 2016, currencies extended losses from April, and local bonds fell for second month. Emerging markets have been battered by seven weeks of dollar gains and by the yield on benchmark 10-year U.S. bonds testing the 3 percent level.