In­vestors can only fac­tor in the short term

The Pak Banker - - OPINION - Henny Sender

IN late Jan­uary US Shale So­lu­tions, an oil­field ser­vices com­pany, an­nounced it was re­struc­tur­ing a debt is­sue. This in­volved a 57 per cent hair­cut on the debt and new terms to al­low it to pay cred­i­tors in­ter­est in se­cu­ri­ties rather than cash, as the num­ber of dis­tressed and de­fault­ing high yield en­ergy com­pa­nies con­tin­ues to rise. Some man­agers say the com­bi­na­tion of stress in this cor­ner of the credit mar­ket and po­ten­tial illiq­uid­ity spell even­tual disas­ter - first for credit mar­kets in the US and, there­after, for ev­ery­one else.

At the same time, ma­jor banks around the world are re­ceiv­ing word from Saudi fund man­agers to liq­ui­date all their man­aged ac­counts. One fund man­ager with ex­po­sures in Ja­pan wor­ries that much of the sell­ing pres­sure on Ja­panese shares comes from Riyadh, as weak oil prices wreak havoc on Saudi bud­gets.

Mean­while, stocks rose in the US the past week as oil prices moved higher, sup­ported by ru­mours that Opec may fo­cus on prices rather than mar­ket share. In­deed, in re­cent days, the US stock mar­ket has be­come far more fix­ated on oil than on dis­crete whis­pers of more eas­ing mea­sures from Europe and Ja­pan.

Cap­i­tal mar­kets are once again emit­ting con­flict­ing sig­nals. Some of those sig­nals have to do with tim­ing and the fear of many shorts that there may be a brief rally on the com­bina- tion of an­other pos­si­ble bout of eas­ing - or de­layed tight­en­ing in the case of the Fed - and signs of sta­bil­i­sa­tion in the en­ergy mar­kets. That helped spreads, or risk pre­mi­ums, nar­row in the high yield mar­ket last week.

But the un­der­ly­ing fun­da­men­tals re­main gloomy. For one thing, the over­all drop in oil prices is a de­mand-side phe­nom­e­non as well as a ques­tion of sup­ply. Less ro­bust, less en­ergy-in­ten­sive growth is a sec­u­lar phe­nom­e­non, de­spite the fact that some con­sumers are buy­ing large ve­hi­cles.

More­over, there is a con­cern that cen­tral banks may be los­ing their ef­fi­cacy. Their lack of ac­tion can lead mar­kets down, while their abil­ity to lift fi­nan­cial as­set prices shows signs of hav­ing less trac­tion than in the past as cen­tral banks re­sort to ever more ex­tra­or­di­nary mea­sures.

A sur­prise shift by the Bank of Ja­pan to adopt neg­a­tive in­ter­est rates for some re­serves on Jan­uary 29 sparked a rally in the share mar­ket and a weaker yen. That said, lead­ing share mar­kets in Ja­pan ended Jan­uary lower by nearly 8 per cent. While mar­kets may en­joy a short-term boost, it re­mains to be seen whether neg­a­tive rates in Ja­pan and the Eu­ro­zone can ul­ti­mately spur higher in­fla­tion and push up as­set prices.

Mean­while, China will also in­flu- ence the prospects of many com­pa­nies on both sides of the Pa­cific. The com­bi­na­tion of the dis­tress in en­ergy and the po­ten­tial lack of liq­uid­ity in credit mar­ket prod­ucts, whether tra­di­tional funds or ex­change traded funds, con­tin­ues to be wor­ri­some - if not to­day then to­mor­row. That may not be im­me­di­ately ap­par­ent, though. When as­set man­ager Third Av­enue im­posed re­stric­tions on in­vestors who wished to with­draw money from one of its credit funds ear­lier this win­ter, the mar­ket shrugged off the ini­tial shock as an out­lier.

There was no im­me­di­ate con­ta­gion. Third Av­enue was easy to dis­miss pre­cisely be­cause many of the hold­ings were ab­surdly illiq­uid and never should have been held by a fund that prom­ises its in­vestors to re­turn their money in a short pe­riod of time in the first place.

Still, it is pos­si­ble to ar­gue that there are of­ten tremors in mar­kets that only in ret­ro­spect turn out to have been clear warn­ing signs. In July of 2007, for ex­am­ple, when two Bear Stearns hedge funds with large sub­prime hold­ings col­lapsed, or the fol­low­ing month when BNP an­nounced it was un­able to value hold­ings of sub­prime se­cu­ri­ties, the di­men­sions of the fi­nan­cial cri­sis stem­ming from such se­cu­ri­ties wasn't yet ap­par­ent for many more months. More­over, many in­vestors, in­clud­ing big buy­out firms, have safe­guarded their en­ergy in­vest­ments with hedges on oil prices. Those hedges will start ex­pir­ing soon, which will force write­downs both for in­vestors and banks.

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