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David Callaway
Aug. 19, 2010, 2:27 a.m. EDT · Recommend (4) · Post:
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By David Callaway, MarketWatch
SAN FRANCISCO (MarketWatch) -- It's a common misperception that nobody saw the financial crisis coming save a few savvy traders. In fact, everybody saw it coming.
It's just that no one knew when or how it would manifest itself. Same thing is happening right now with the bond bubble.
Visitors to the trading floors, bars, pubs and restaurants in New York and London from 2004 through 2006 would commonly hear investors and financial types counting their blessings and profits, and saying, "when this thing finally ends it's going to be ugly."
The relative riskiness of bonds is probably greater than most investors acknowledge relative to stocks, according to Barron's Michael Santoli.
Most people speculated it would be tied to derivatives, which meant mortgages. The media, including MarketWatch, was full of stories about crazy prices and ridiculous lending practices, as well as the dangers of securitization and cutting mortgages into pieces to diversify the risk.
But nobody, at least that I have heard from yet, thought "ugly" meant we'd see a run on Northern Rock in the U.K., and the collapse of Bear Stearns, Washington Mutual and finally, Lehman Brothers.
That's the way it is with financial bubbles and busts. People can see them coming, but they don't know where they will hit or how hard. As Bloomberg columnist Mark Gilbert said in his book about the latest crisis, "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable," it was caused by a "conspiracy of the well-rewarded."
Confident something will happen but unable to give up those last few pennies of profit for fear of missing out, everybody hangs in there until the last possible moment, when the race for the exit begins.
In retrospect, the 9% decline in stocks in Shanghai in one day in February 2007, was the beginning of the crisis. But nobody thought much about it at the time, especially once stocks bounced back. It would be six months before Northern Rock shuddered and shook Britain, and a year before Bear Stearns collapsed. But even that spring of 2007, MarketWatch -- and others -- were writing about the coming subprime lending crisis. See 2007 MarketWatch story on whether lemming loans will drive the economy off a cliff.
It's a natural inclination to follow greed as far as it will go, which is always too far. This summer's repeated headlines and stories about the bond bubble bursting serves as a stark reminder of this phenomenon. Everybody knows that this period of low rates is unsustainable, but investors continue to plow money into bond funds. Once the end happens, it will be difficult to get out without losses. But nobody wants to be the first.
There are increasing signs that something is going to have to happen soon. European bond yields, particularly sovereign yields, are at levels not seen since the teeth of the Greek/Ireland/Portugal/Spain debt worries this past spring. Junk bond sales are booming as investors search for yield, throwing risk to the wind. Gold is hitting new highs. This past week, mortgages lenders witnessed a surge in refinancings even beyond the strong rally they've seen all summer. Equity trading volumes are pathetic.
And underlying all the worries is a growing concern that the free markets, once manipulated with derivatives, are now being manipulated by governments and central banks, as they use every possible technique to keep interest rates low to try to stir up some sort of economic rebound.
On Wednesday, Minyanville founder Todd Harrison noted in his weekly MarketWatch column that some of his Wall Street buddies were "going dark" in terms of trading or running their trading businesses this summer. See Todd Harrison's column on investors going dark.
A few hours later, famed hedge fund manager Stanley Druckenmiller inflated the exit chute on his 30-year business, Duquesne Capital Management, a two-hour exclusive interview given to Bloomberg News serving as his figurative beer in hand, a la Jet Blue's Stephen Slater. The man who helped George Soros bust the British pound in 1992, generating more than $1 billion for the firm, said he's tired of managing other people's money. See story on Druckenmiller shutting his firm.
Duquesne's closure follows similar shutdowns at hedge funds such as Raptor Global, Pequot Capital, and the largest fund at Atticus Capital, among others.
Druckenmiller also said the $10 billion size of the fund company made it difficult to replicate the performance it's enjoyed over the years. In three decades, it has never lost money in any year, until this year, in which it's down 5%.
This is troubling. For somebody as savvy as Druckenmiller wouldn't turn away from the opportunity to make a fortune in the next crash if he thought one was right around the corner. Rather, it indicates that perhaps he and his fellow hedge fund managers expect nothing to happen for some time -- an endless low-interest rate layover, if you will -- which is why they have pulled the chute. Think Japan, and you can see where this could lead.
If that's the case, then we'll still have fits and starts, so we may still see the spike in global stocks in the later half of this year that the bulls are forecasting. Indeed, I have written that the fourth quarter could be a great one for stocks after a lackluster year and a scary third quarter.
But a rally in stocks would only portend a real recovery in the economy, which would be bad for bonds. And when that bond market finally does turn, mark my words; it's going to be "ugly" for just about every asset class out there for awhile. And your guess of what "ugly" is will probably be as good as mine.
The only thing that's certain is that everyone will be surprised.
David Callaway is editor-in-chief of MarketWatch.
David Callaway is editor-in-chief of MarketWatch, responsible for the global news coverage of 100 journalists in 12 bureaus in the U.S., Europe and Asia. A financial journalist for more than 20 years, Callaway has worked for Bloomberg News, the Boston Herald, and assorted television and cable stations as a reporter, columnist and commentator.
For those who are interested in buying General Motors once it goes public again, you won't be able to say you weren't warned.
5:23 p.m. Aug. 18, 2010 | Comments: 102
- albender | 11:45 p.m. Aug. 18, 2010
"Big investors pull exit chute, beer in hand: It's a common misperception that nobody saw the financial crisis... http://on.mktw.net/coO5qN" 11:44 p.m. EDT, Aug. 18, 2010 from dcallaway
"BlackBerry enemies piling up for RIM: As if having Steve Jobs breathing down your neck isn't bad enough, Blac... http://on.mktw.net/96Lamq" 1:46 a.m. EDT, Aug. 5, 2010 from dcallaway
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