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The State of Global Lending

Opportunities created by The Mini Crisis of 2015-2016

Paul DeNoonTune in as Spencer McGowan interviews Paul DeNoon, Director –Emerging Market Debt, senior member of the Global Fixed Income and Absolute Return teams at AllianceBernstein. He oversees a variety of global fixed-income assets and has overall responsibility for all of the firm’s Multi-Sector teams. DeNoon is also Portfolio Manager for the Next 50 Emerging Markets Fund and a member of the EM Multi-Asset Strategy Committee, the Dynamic Asset Allocation Committee and a number of other management committees. Prior to joining the firm in 1992, he was a vice president in the Investment Portfolio Group at Manufacturers Hanover Trust and an economist in the bank’s Financial Markets Research Group, where he was primarily responsible for the analysis of monetary and fiscal policy. DeNoon began his career as a research analyst at Lehman Brothers. He holds a BA in economics from Union College and an MBA in finance from New York University.


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The Mini-Crisis of 2015-2016

Key Factors:

  • The Restructuring of Global Lending Markets and Liquidity
  • Equity Overpricing and The Stall of Earnings Growth
  • Structural Defects in the Chinese Markets
  • The Oil Implosion
  • Potential Economic Slowdown

After struggling to name the recent mini crisis in global financial markets, we finally arrived at “The Mini Crisis of 2015-2016.”

Careful examination of the key factors in the Mini Crisis combined with estimates of forward rates of return in different asset classes provides a foundation for 2016-2020 investment strategy.

  • The Restructuring of Global Lending Markets and Liquidity

We were warned in a meeting during 2015 with Marvin Loh, Bank of New York’s Senior Global Markets Strategist, that the implementation of Dodd Frank has created gaps in certain bond markets resulting in restrictions on banks carrying inventories of bonds.  Subsequently, dealer inventories have been systematically reduced compared to the “traditional” level of bond inventories held.

While this disintermediation has created short term gaps in prices, the longer term implications for global lending portfolios could be a paradigm shift in advantages to investors.  In the old structure, the broker dealers would provide a market making function in both municipal bonds and corporate bonds.  Bidding low to buy inventory cheap and offering the bonds back to the customers at significant mark-ups in price.  This profit center, in many cases worked against the best interest of the customers for obvious reasons.   However, in stark contrast to the old structure, investors can have access to this “closed system” to provide two coveted components of total return:  current income and capital gain potential.  The MGAM bond desk has been providing this access for the last few years. Through the conduit of the electronic commerce networks, customer bids and offers will continue to be unleashed providing much needed liquidity to bridge “the gap.”

The current correction has impacted prices in the U.S. corporate high yield market, in many cases, more than equity index pricing:

HighYieldMarket

Graph courtesy of Bloomberg L.P.

 

  • Equity Overpricing and The Stall of Earnings Growth
  • Structural Defects in the Chinese Markets

Several months after the launch of the Ali Baba IPO, we did a presentation on the different shares classes of Chinese equity.  At least 7 different types of shares were defined in the broadcast.

The conclusion was that it would be very difficult for a single company or investor to buy and own an entire Chinese company.  One of the reasons for liquidity in U.S. equity markets is the ability for another company or investment group to launch an honest bid to buy and control an entire company.

As of February 23rd, 2016 the Chinese Shanghai Composite Index was down 18% since the beginning of the year.

Shanghai

Graph courtesy of Bloomberg L.P.

 

The U.S. equity markets began the current correction at about the same time as the Chinese equity markets.

Dow-2Yrs

Graph courtesy of Bloomberg L.P.

  • The Oil Implosion

The current correction correlation in oil prices, high yield corporate bonds, and equity prices has become remarkable and provides some guidance for investors.   Concerns over slowing growth, oil defaults, and oil related stocks have clearly outweighed positives for the consumer in the form of cheaper gasoline as well as rising home prices, airlines, and other fuel consuming industries.

  • Potential Economic Slowdown

According to Ken Hersch of NG Partners at a recent speech given at SMU with Commerce Street Capital, the oil price implosion has been supply driven, not driven by a collapse in demand normally associated with recessions.

USGDP

Graph courtesy of Bloomberg L.P.

 

If this is recession, the numbers have yet to show one based upon the graph above.

Conclusions


The mini-crisis of 2015-2016 is not the great recession.   Discounted global lending portfolios including high yield bond portfolios could provide some of the best opportunities in the face of an equity market that appears range bound or stalled.