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business newsThe Botox Economy, Part 1
On the surface, the global financial situation is glossy and smooth, but the interior is decayed and rotten.
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The global economy is currently taking the "botox" cure. A flood of money from central banks and governments -- "financial botox" -- has temporarily covered up unresolved and deep-seated problems.The surface is glossy and smooth, the interior decayed and rotten.
Bad Risks
In 2009 there was a "recovery" in financial asset prices. The low or zero interest rate policy (ZIRP) of major central banks helped increase asset prices. Very low returns on cash or near-cash assets forced investors to switch to riskier assets in search of return. Even Pimco’s Bill Gross discovered that his cash assets paid near-zero returns.
The chase for yield drove rallies in debt and equity markets. Low interest rates acted like amphetamine as investors re-risked their investment portfolios.
High credit spreads for investment quality companies, driven by the panic of late 2008 and early 2009, subsided and rates returned to pre-Lehman levels. Credit spreads for investment-grade borrowers fell to just over 100 basis points from their highs of 300 basis points in March 2009.
Credit spreads for non-investment grade or junk borrowers market fell to over 500 basis points from the high of 1,300 basis points in the same period, driving returns of over 50% per annum (pa). Extremely low rated bonds, such as CCC-rated bonds (a mere one notch above default), generated even higher returns falling from rates of 30-40% pa to around 10% pa.
Debt markets were also underwritten by central bank purchases of structured securities. Central banks were the buyers of first and last resort for asset backed securities (ABS) and mortgage backed securities (MBS) driving large gains for holders.
Stocks rallied, in part, because of the dividends on offer. Another driver was fear of inflation, based on the loose monetary policies of central banks.
Re-risking was helped by the return of the "carry trade" as investors used near zero cost funds, especially in dollars, to finance holdings of risky assets. Any asset offering a reasonable return rose sharply in value. Morgan Stanley analyst Greg Peters outlined the outlook for 2010 in the Financial Times: "We like the junkiest of the junk…"Buying drove up prices, encouraging further buying and reinforcing the "recovery" in asset prices. Index-tracking investors and competitive pressures amongst fund managers further underwrote the rally. The recovery became widespread, spreading across most asset classes. Naysayers were dismissed as perma-bears. As everyone knows: "A bubble is a rising market that one is not invested in; if one is invested, then it is a bull market."
In contrast, the real economy, at best, stabilized during 2009. Most economies -- with the exception of Australia and some emerging markets, most notably China and India -- contracted during 2009. In Australia, which avoided a recession, GDP per capital actually fell (by around 1.5% pa). Key real economy indicators, including employment, consumption, investment and trade, remained weak.
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