Asset Allocator: January 2016

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ASSET ALLOCATOR: 18th January, 2016

 

This week I went to briefly dwell on a gaggle of informative graphics. They tell us very different things about risk and investing, as well as the probability of a global recession but they’re all instructive about the market turbulence in their own way

The first table is below and shows the current (as of January 14th) CDS options rates for leading banks. A CDS is in effect an insurance policy that gives the investor in bonds issued by banks some protection in case if default. A bank CDS rate – expressed in basis percentage points, is an advanced indicator or signal about market concerns for impending financial risk in the banking system. If CDS rates spike you would expect to see significant evidence of financial distress amongst the big globally important banks and real fears of a financial meltdown.

The table below demonstrates two remarkable truths. The first is that bank CDS rates are becalmed and at historically very low rates. Over the last few months these rates have in fact barely budged, indicating very little fear of banking defaults. The second fact is that these rates have tightened across the board, with most banks now trading in a range of 20 to 50 basis points for insuring 1 year bonds. Within this narrative though there are some extra ordinary turnarounds. Until just a few years ago for instance HSBC boasted some of the lowest CDS rates in the world. Its rates have since crept up (marginally). By contrast RBS once boasted some of the highest CDS rates. Now RBS options trade BELOW those of HSBC.

Regardless of the individual moves, these numbers tell us an important story. Investors are not remotely worried about systemic financial distress within banking.

 

14th January 2016

Bank

OneYear

FiveYear

MonthlyChange

AnnualChange

Credit Rating

Banco Santander

55

120

-3

40

A-

Barclays

20

59

0

6

A

Citigroup

29

83

1

9

A

Commerzbank

39

88

1

7

A+

Credit Suisse

41

84

5

31

A

Deutsche Bank

44

94

4

19

A+

Goldman Sachs

35

86

3

-2

A

HSBC

27

68

1

24

AA-

JP Morgan

37

76

3

11

A+

Lloyds

27

49

1

0

A

Morgan Stanley

33

86

2

2

A

Nomura

21

68

3

-21

A-

Rabobank

22

50

-5

6

AA-

RBS

18

58

-10

7

A

Soc Gen

40

70

-3

-26

A

UBS

27

46

-5

-5

A

Source: Bloomberg, January 2016.

The next two charts – both from earlier in 2015 and both from Bloomberg Views – tells another rather more concerning story. In my monthly review article, looking at prospects for 2016, I specifically warned about the risk from emerging market bonds.

The chart above shows which countries foreign debt figures prominently in bank balance sheets. Malaysia and Chile are top of the list – neither in my view presents a very large systemic risk. The same goes for Taiwan and Mexico but I would be concerned about Turkey and especially South Africa.

Source - http://www.bloombergview.com/articles/2015-08-24/spain-u-k-taiwan-stand-to-lose-in-emerging-markets

The next chart flips this analysis around and looks at which country’s banking systems are most vulnerable. Top of the list is perhaps unsurprisingly is Spain (think of all that LatAm exposure) but UK banks are in at number two. Perhaps those remarkably low bank CDS rates for UK institutions (all the major UK banks 1 year CDS rates trade below 30 basis points) aren’t quite as useful as they first appear.

The next three charts are from the American Bankruptcy Institute and they focus in one core concern about financial stability – loan default rates. EM bonds might be one systemic threat to the banking system (and thus CDS rates) but most commentators would argue that the real danger comes from ordinary domestic corporate and consumer loans going sour.

What’s the evidence here that banks – and thus investors – need to worry? Two parallel stories emerge. The first concerns resource firms and especially energy firms. My own view is that investors need to anticipate a huge wave of corporate defaults in the first half of 2016 as energy firms go to the wall. The chart below only shows numbers for 2015 when oil prices were still above $35 a barrel. My guess is that they’ll settle in at levels well below $20 a barrel as 2016. Expect the bankruptcy levels to at least double. Over in the mining space we could also see default rates shoot up, especially as industrial metal prices are dragged ever lower by oil prices – default rates could easily shoot past 25%.

Source: http://www.abi.org/newsroom/chart-of-the-day/metalsmining-default-rate-vs-high-yield-default-rate

But another story also emerges from the two charts above and below. In the chart above we can see overall high yield default rates. These have edged up slightly but there is absolutely no evidence to suggest we’ve seen any remotely worrying increase in defaults or at least not with rates of just over 2%. In fact, the chart below (looking at a very different loans segment, mortgage loans) shows that first time foreclosure starts are in fact at the lowest level for TEN years. The energy market may be approaching bankruptcy but the wider US economy is showing no signs of worrying about debt levels.

Source : ABI

The last chart below hints at one final concern – plunging government bond rates. All the numbers above look at systemic financial risk through backward looking measures. The chart below from the Trading Economics website looks at the yield on ten year UK government bonds or gilts. The current level is at 1.7%, one of the lowest levels since the global financial crisis. These low rates suggest that investor’s are worried about an impending recession – 10 year gilt yields tend to fall ahead of an impending recession as investors use gilt yields as an indicator of impending financial stress. If we see a decisive break below yeilds of 1.6% and then 1.5%, we could be entering dangerous territory with bond investors signalling a downturn in the next few months.

Overall though I still think this view is overly bearish. Apart from a wave of corporate defaults in the energy sector, I can’t see any obvious evidence of a full blow financial crisis emerging. Correction yes, a repeat of 2008, not yet.

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The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.

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