Jan

25

Speaking of rarities, one of the issues I have been grappling with as the market decline continued is that this period reminds me of a combo of the 1989-1990 junk bond debacle and the Oct 2002 US accounting "crisis"; current conditions are worse than in the former case and better than in the latter. Mix them together and what do you have? I continue to search for the answer daily.

On the one hand, as the bond insurers are impacted by downgrades and fears of possible bankruptcy, billions and billions of previously AAA rated securities (thanks to bond insurance) now have to stand on their own merits. Who is to say what the average rating of many of these instruments is, BBB, BB? By default (no pun intended), the removal of insurance or ratings causes forced liquidations by parties which can only hold the highest rated paper. Given all the structured product created in say the last 3-5 years, where is the home for all this paper? It was one thing when the S and L's of old held Milken's junk and had to sell it without regard to price: there were adequately capitalized parties which could absorb the inventory with the proper markdowns. Will the newly downgraded structured products overwhelm even the vulture funds and opportunistic hedge funds' ability to buy? And are we seeing equities decline because the competition for return is swinging to the newly created fixed income opportunities with better implied ROR? I'm told plain vanilla junk is now trading around +1100 from +400 to +600 in the last few years; historically wide by most accounts but not at max spread to previous distress periods.

What reminds me of the accounting crisis period is the disgorging of US equities in buckets as we've witnessed the last few weeks; very little discernment of company by company fundamentals. I can remember at my old fund, in the height of the accounting debacle, seeing Kroger (KR) among many, many others, drift down from 23 to 15 in a matter of days and within 1 day trade "in the hole" to 10.75 briefly. Within 8 hours the stock was back to 14.50 and proceeded to drift back up to the low 20s within a few months. I mention this as an example because as I recall this was a single A issuer with NO accounting issues whatsoever, recession proof and a steady income stream trading at 5 to 7x EBITDA depending on where you marked it. I can look back and point to example after example of similar situations in that period. I'm sure many others can mention a laundry list of current stocks which should not be impacted by bond market turmoil other than that the equity risk premium is increasing "because it is". Aside from the realization that US and global GDP are slowing rapidly, these are some of the other ingredients for this manic depressive market. 

I remain optimistic especially after the severe markdown we've had but the unique qualities of this period do give me pause. Would welcome any comments. 


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