A Few Investment Notes by David Merkel, CFA of AlephBlog
Just a few notes for this
1) I’ve been a bull on the long end of the Treasury curve for a while. It’s been a winning bet, and the drumbeat of “interest rates have nowhere to go but up” continues. Here’s an argument from Jeffrey Gundlach on why long rates should remain low, and maybe go lower:
ValueWalk's Raul Panganiban interviews Joseph Cioffi, Author of Credit Chronometer and Partner at Davis + Gilbert where he is Chair of the Insolvency, Creditor’s Rights & Financial Products Practice Group. In the interview, we discuss the findings of the 3rd Annual report. Q2 2021 hedge fund letters, conferences and more The following is a computer Read More
Gundlach, however, was one of the very few people who believed rates would stay low, especially with the Federal Reserve committed to keeping rates low with its loose monetary policy.
It’s important to note that U.S. Treasuries don’t have the lowest yields in the world. French and German government bonds have yields that are about 100 basis points lower than those of Treasuries. In other words, those European bonds actually make U.S. bonds look cheap, meaning that yields have room to go lower.
This will trend toward lower rates will eventually have to end, but neither GDP growth, inflation, or business lending justifies it at present.
2) From Josh Brown, he notes that correlations went up considerably with all risk assets in the last bitty panic. Worth a read. My two cents on the matter comes from my recent article, On the Recent Anxiety in High Yield Bonds, where I noted how much yieldy stocks got hit — much more than expected. I suspect that some asset allocators with short-dated or small stop-loss trading rules began selling into the bitty panic, but that is just a guess.
3) That would help to explain the loss of liquidity in the bond market during the bitty panic. This article from Tracy Alloway at the FT explores that topic. One commenter asked:
Isn’t it a bit odd to say lots of people sold quickly *and* that there isn’t enough liquidity?
Liquidity means a number of things. In this situation, spreads widened enough that parties that wanted to sell had to give up price to do so, allowing the brokers more room to sell them to skittish buyers willing to commit funds. Sellers were able to get trades done at unfavorable levels, but they were determined to get the trades done, and so they were done, and a lot of them. Buyers probably had some spread target that they could easily achieve during the bitty panic, and so were willing to take on the bonds. Having a balance sheet with slack is a great thing when others need liquidity now.
One other thing to note from the article is that it mentioned that retail investors now own 37% of credit, versus 29% in 2007, according to RBS. Also that investment funds has been able to buy all of the new corporate debt sold since 2008.
There’s more good stuff in the article including how “matrix pricing” may have influenced the selloff. When spreads were so tight, it may not have taken a very large initial sale to make the estimated prices of other bonds trade down, particularly if the sales were of lower-rated, less-traded bonds. Again, worth a read.
4) Regarding credit scores, three articles:
- Are We Giving Americans Too Much Credit?
- FICO Recalibrates Its Credit Scores
- On Credit Scores (an old article of mine)
From the WSJ article:
Fair Isaac Corp. said Thursday that it will stop including in its FICO credit-score calculations any record of a consumer failing to pay a bill if the bill has been paid or settled with a collection agency. The San Jose, Calif., company also will give less weight to unpaid medical bills that are with a collection agency.
I think there is less here than meets the eye. This only affects those borrowing from lenders using the particular FICO scores that were modified. Not all lenders use that particular score, and many use FICO data disaggregated to create their own score, or ask FICO to give them a custom score that they use. Again, from the WSJ article:
Fair Isaac releases new scoring models every few years, and it is up to lenders to choose which ones to use. The new score will likely be adopted by credit-card and auto lenders first, says John Ulzheimer, president of consumer education at CreditSesame.com and a former Fair Isaac manager.
Mortgages are likely to lag, since the FICO scores used by most mortgage lenders are two versions old.
The impact of the changes on borrowers is likely to be significant. Accounts that are sent to collections, including credit-card debts and utility bills, can stay on borrowers’ credit reports for as long as seven years, even when their balance drops to zero, and can lower their scores by up to 100 points, said Mr. Ulzheimer.
The lower weight given to unpaid medical debt could increase some affected borrowers’ FICO scores by 25 points, said Mr. Sprauve.
But lowering the FICO score by itself doesn’t do anything. Some lenders don’t adjust their hurdles to reflect the scores, if they think the score is a better measure of credit for their time-horizon, and they want more loan volume. Others adjust their hurdles up, because they want only a certain volume of loans to be made, and they want better quality loans at existing pricing.
Megan McArdle at Bloomberg View asks a different question as to whether it is good to extend more credit to marginal borrowers? Didn’t things go wrong doing that before? Her conclusion:
That in itself [DM: pushing for more loans to marginal borrowers as a matter of policy] is an interesting development. Ten years ago, politicians were pressing hard for banks to extend the precious boon of homeownership to every man, woman and shell corporation in America. Five years ago, when people were pushing for something like the CFPB, the focus of the public debate had dramatically shifted toward protecting people from credit. Oh, there were complaints about the cost of subprime loans, but ultimately, on most of those loans, the problem wasn’t the interest rate but the principal: Too many people had taken out loans that they could not realistically afford to pay, especially if anything at all went wrong in their lives, from a job loss to a divorce to an unexpected illness. And so you heard a lot of complaints about predatory lenders who gave people more credit than they could handle.
Credit has tightened considerably since then, and now, it appears, we’re unhappy with that. We want cheaper, easier credit for everyone, and particularly for the kind of financially struggling people who have seen their credit scores pummeled over the last decade. And so we see the CFPB pressing FICO to go easier on people with satisfied collections.
That’s not to say that the CFPB is wrong; I don’t know what the ideal amount of credit is in a society, or whether we are undershooting the mark. What I do think is that the U.S. political system — and, for that matter, the U.S. financial system — seems to have a pretty heavy bias toward credit expansion. Which explains a lot about the last 10 years.
Personally, I look at this, and I think we don’t learn. Credit pulls demand into the present, which is fine if it doesn’t push losses and heartache into the future. We are better off with a slower, less indebted economy for a time, and in the end, the economy as a whole will be better off, with people saving to buy in the future, rather than running the risk of defaults, and a very punk economy while we work through the financial losses.