Over the short and medium term, what do you think is Wall Street's worst case scenario?
How many of you would say "a run on bonds"? If so, you're in good company according to a recent piece in Businessweek.
Since the financial crisis, $900 billion has flowed into bond mutual funds and ETFs such as Scout Unconstrained, bringing the industry’s total holdings to $3 trillion. Fund investors who sell shares get their money back almost immediately, as if they were making a withdrawal from a money-market fund. The bonds that the funds own are far less liquid, often trading in telephone conversations or e-mails between brokers, away from exchanges. If too many people decide to get out of bond funds at the same time, the wave of selling could lead buyers to sit on their hands, bringing the system to a halt.
Pressure on the system caused by redemptions, in particular via strains on cash appear to be the culprit. However, there are a variety of opinions on the matter all of which seem to be rooted in the adequacy of cash reserves:
“Many funds already carry a fair amount of cash” to meet redemptions, Ira Jersey, director of U.S. rates strategy at Credit Suisse, wrote to clients on June 24. Taxable bond funds have 9.5 percent of their portfolios in liquid assets such as cash and U.S. Treasuries, according to Credit Suisse, more “than most would assume.”Brian Reid, chief economist at the Investment Company Institute, says interest rate shocks are nothing new, and the system has held before—as in 1994, when the Fed doubled its benchmark rate to 6 percent over 12 months, catching many investors unprepared. “Markets aren’t nearly as fragile as people worry about,” Reid says. “I would put ‘massive outflows from bond funds’ at such a low level of probability—even during the financial crisis we didn’t have that—it doesn’t rise to the level of systemic risk that has been portrayed.”
Granted, while Reid appears to make a compelling point, banking today and banking in the mid-90s are different beasts, as we all know. A particular difference is the change in operations due to Dodd-Frank, as noted in Businessweek:
The biggest banks, faced with new rules meant to curb risk, have reduced their trading operations—making it harder for them to opportunistically buy large chunks of bonds they could hold and then sell at a profit over time. That means they no longer have the same power to act as stabilizers in a tumultuous market. “Wall Street dealers are not fulfilling the same sort of function that they were 10 years ago,” Jacobson says. “So much of the market capacity that the banks used to handle has essentially shifted to mutual fund owners.”
So, are bond runs the biggest source of future risk? Is there some other looming issue that nobody has thought of? What does everyone think?
Worst scenario? A precipitous drop 10-15%, rally back, and then a slow bleed lower for 2.5-3 years as credit conditions change. Probably will play out that way too, boom & bust cycle. Same as it ever was.
worst case scenario is De Blasio declaring a ban on slicked back hair.
massive bond exit would be bad, but I think it's unlikely because of the pace of the Fed and the lack of yield in the other 2 big sovereign debt markets (Deutschland and Japan).
I don't want to be the guy who says "this time things are different," but I doubt we are going to see another 2008 event for a long time. Probably just your standard correction. I'd venture to guess that tech will get it the worst, but what do I know?
I 100% agree with you, and the data support you. what makes me nervous is that we haven't seen a 10% correction since 2011, and these types of corrections should be seen about every year. 20% corrections should be seen every 3.5-4 years, so we're a bit overdue, but a 40%+ decline like 08? maybe towards the end of my career, sure, but I'd be very surprised if that happened any sooner than 30 years from now.
The Fed has made it pretty clear that they want all asset prices to go up, and keep going up, for the foreseeable future via all the intervention over the past year. Nothing scares a central banker like a vastly over levered economy with the possibility of deflation.
Frankly, what scares me more is the impact of stagnating wage growth coupled with increased inflation all over the place. That eventually slows everything down because we are reliant on the consumer to keep pushing things along. Granted, they can borrow like crazy for awhile but we've seen that happen before. I don't know. I think everything that has happened over the past few years has actually given me a lobotomy.
Agree as well.
As to @"thebrofessor", a 10% correction every year? I thought it was 20% every 6 ... possibly just remembering undergrad professors incorrectly. Even if 10% is the norm, I doubt there'll be anything that drastic any time soon. '08 shocked the markets so much that it'll take twice as long as usual (i.e. 2 full market cycles, ~12-15 years?) to get back to where the regular historical rhythm sets in.
Edit: Not to mention, we're in unexplored territory when considering the level of involvement of the Fed/lending ability. It just seems like the market in general is not ready for a correction, not quite yet.
http://americanfundsretirement.retire.americanfunds.com/basics/volatile…
those are averages, and we all know the problem with averages, these things don't happen on a clock, but history tells us that we should've had one by now, which means 1 of 2 things: the averages are changing, or we're due for more than the average in the near term.
All in.
I'd like to throw my two cents in and mention that statistical patterns don't dictate precipitous market events; conditions do. You'll be left shirtless someday sooner than you expect if you bet the farm thinking that statistics has bought you x years before a y event.
My worst case wall-street scenario is either land/sea pitched warfare in the south-china sea destabilizing asia or hedge funds/PE GPs blowing up when the 'distressed credit' bubble finally deflates.
An article recently came out discussing how BlackRock sees this as an issue as well. I can't post links but the article is called "BlackRock Urges Fund Scrutiny to Contain Redemption Risk". Came out June 19th. They are pushing for greater redemption restrictions as a way to manage this risk.
Wall Street's worst case scenario is if this is a conservative estimate:
http://www.businessinsider.com/block-chinas-gdp-faces-25-correction-201…
Ira jersey is brilliant. Met him once
Mark this post we're seeing a huge bull market for at least... 3-5 more years. Increasing profits with less employees and better technology, interest rates boxed in - thus bonds being terrible investments because when rates rise... we all know what happens to prices. Also, the wealth effect, pension funds needing a place to get a higher return on their money to ensure they meet their overly optimistic guidelines. The list goes on. Not saying we won't see a 5-10% correction, we very well may. But 20%? No chance in hell, barring any geopolitical terrorism or bank collapse.
Perhaps it's just me, but I don't exactly associate less employees with a thriving economy. At some point, I'd like to see economists wake up and instead of fellating technology- realize that it's actually precisely the problem. Just kidding, I see nothing wrong with an economy needing less and less workers. Artificially low interest rates should fix that right up.
Since the chance is not zero percent, worst case scenario is people get pissed and start hanging politicians, lobbyists and Wall Street bankers. This would be even more likely if Wall Street causes a crash worse than 2008.
I'd definitely watch that.
I don't think we will see it in the near-term, but wage stagnation/middle class will become a problem.
No one gives a fuck right now, because bonus cash is flowing and 401k's are bursting at the seams. That short-term mentality... but eventually, all those displaced workers from efficiency gains/technological employment/whatever won't be able to keep buying goods. Rent growth is something to consider, as well. There will be more and more serfs, and a weaker and weaker economy.
Also, regarding real inflation...does anyone know what the deal with Shadowstats is? Is it legit? Their methodology seems to make sense.
Well, shadow stats to me is someone looking at government statistics and applying real world common sense rather than getting lost in the clouds of academia and economics. I'd say it is very legitimate, probably more so than zero hedge.
I agree with some of the more dire scenarios if you're asking for worst case Wall Street scenarios. War with or in China, a Chinese collapse of some sort (which I actually don't see as out of the realm of the possible in a political sense: China's social pact is essentially that they'll take a shitty totalitarian government as long they get this spectacular growth so that more peasant farmers can get jobs in sweat shops so that they too can have a flat screen tv, and it's showing signs of slowing and the numbers the Chinese government uses to state growth make US inflation and unemployment numbers look as definitive and true as π), civil unrest in this country (I'm not a fan, but if OWS had been slightly better organized or had a single charismatic leader and they weren't just sitting around in parks around the country smoking pot, things could have gotten pretty messy), conflict with Iran and/or Russia, and the list goes on.
I'm not a tin foil hat wearing wacko living in my parent's basement, but I feel like things have been too quiet in the world for too long. The last real big event in the world was WWII (yes, conflicts here and there so I'm not discounting Vietnam, Afghanistan, etc) and it just seems like it's time for something big to happen again.
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