Peddling the Credit Cycle

9142514184_9c85b423ae_zStarting again with another letter from a reader, but I will just post his questions in response to this article:

1) How much emphasis do you put on the credit cycle? I guess given your background rather a great deal, although as a fundamentals guy, I imagine you don’t try and make macro calls.

2)  What sources do you look at to make estimates of the credit cycle? Do you look at individual issues, personal models, or are there people like Grant’s you follow?

3) Do you expect the next credit meltdown to come from within the US (as your article suggests is possible) or externally?

4) How do you position yourself to avoid loss / gain from a credit cycle turn? Do you put more emphasis on avoiding loss or looking for profitable speculation (shorts or quality)

1) I put a lot of emphasis on the credit cycle.  I think it is the governing cycle in the overall economic cycle.  When some sector of the economy finds itself under credit stress, it has a large impact on stocks in that sector and related areas.

The problem is magnified when that sector is banks, S&Ls and other lending enterprises.  When that happens, all of the lending-dependent areas of the economy tend to slump, especially those that have had the greatest percentage increase in debt.

There’s a saying among bond managers to avoid the area with the greatest increase in debt.  That would have kept you out of autos in the early 2000s, Telecoms after that, and Banks/Finance heading into the Financial Crisis.  Some suggest that it is telling us to avoid the junior energy names now — those taking on a lot of debt to do fracking… but that’s too small to be a significant crisis.  Question to readers: where do you see debt rising?  I would add the US Government, other governments, and student loans, but where else?

2) I just read.  I look for elements of bad underwriting: loosening credit standards, poor collateral, financial entities focused on growth at all costs.  I try to look at credit spread relationships relative to risks undertaken.  I try to find risks that are under- and over-priced.  If I can’t find any underpriced risks, that tells me that we are in trouble… but it doesn’t tell me when the trouble will hit.

I also try to think through what the Fed is doing, and think what might be harmed in the next tightening cycle.  This is only a guess, but I suspect that emerging markets will get hit again, just not immediately once the FOMC starts tightening.  It may take six months before the pain is felt.  Think of nations that have to float short-term debt to keep things going, particularly if it is dollar-denominated.

I would read Grant’s… I love his writing, but it costs too much for me.  I would rather sit down with my software and try to ferret out what industries are financing with too much debt (putting it on my project list…).

3) At present, I think that an emerging markets crisis is closer than a US-centered crisis.  Maybe the EU, Japan, or China will have a crisis first… the debt levels have certainly been increasing in each of those places.  I think the US is the “least dirty shirt,” but I don’t hold that view strongly, and am willing to be challenged on that.

That last piece on the US was written about the point of the start of the last “bitty panic,” as I called it.  For a full-fledged crisis in US corporates, we need the current high issuance of  corporates to mature for 2-3 years, such that the cash is gone, but the debts remain, which will be hard amid high profit margins.  Unless profit margins fall, a crisis in US corporates will be remote.

4) My goal is not to make money off of the bear phase of the credit cycle, but to lose less.  I do this because this is very hard to time, and I am not good with Tactical Asset Allocation or shorting.  There are a lot of people that wait a long time for the cycle to turn, and lose quite a bit in the process.

Thus, I tend to shift to higher quality companies that can easily survive the credit cycle.  I also avoid industries that have recently taken on a lot of debt.  I also raise cash to a small degree — on stock portfolios, no more than 20%.  On bond portfolios, stay short- to intermediate-term, and high to medium high quality.

In short, that’s how I view the situation, and what I would do.  I am always open to suggestions, particularly in a confusing environment like this.  If you’re not puzzled about the current environment, you’re not thinking hard enough. ;)

Till next time.

Peddling the Credit Cycle was originally published on The Aleph Blog

View Comments (0)

Recommended for You

  • 3 Lessons An Investor Learned After Losing His Job, Reputation, And $1.6 Million

    The late Jim Paul went from a poor Kentucky boy to serving on the board of governors of the Chicago Mercantile Exchange through a series of lucky breaks and smart investments. By 1990 he was working in the futures research department at Morgan Stanley Dean Witter & Co., managing a team that…

    Business Insider
  • Enjoy this refreshing Triple Play offer!

    Get FIOS TV Mundo starting at $79.99/mo. w/ no annual contract + 2-yr. price guarantee. Or sign for 2 yrs. & get a $300 prepaid Visa. Click here.

    AdChoicesVerizon FiOS ®Sponsored
  • Bill Gates Is At Least $6 Billion Richer Than He Was Six Months Ago, But Not From Microsoft

    In July, Bill Gates may or may not have lost his title as the world's richest man. According to Forbes, Gates has a net worth of almost $82 billion, which puts him in the No. 2 spot behind Mexican telecom magnate Carlos Slim, who's worth $85.4 billion. According to Bloomberg, Gates is still the…

    Business Insider
  • Silver Is Getting Crushed

    Silver is getting crushed. On Friday, Silver fell more than 3% to less than $18 an ounce, its lowest level in more than four years. The price of gold also fell about 0.8% and touched its lowest level since January.

    Business Insider
  • Bitcoin tanks, is Alibaba to blame?

    The price of bitcoin has plummeted in the past few days, and some are blaming the Alibaba IPO for the virtual currency's fall. Members of the bitcoin community are pointing fingers at the e-commerce giant's IPO, suggesting that tech-minded China-centric money is being pulled out of the currency in…

    CNBC
  • Eric Holder’s Shameful Legacy on Wall Street Fraud

    Right in the middle of the midterm election season, and just before Attorney General Eric Holder reportedly might step down, he made it known that the Justice Department will really really indict Wall Street executives in financial fraud cases. “We expect to bring charges in the coming months,”…

    The Fiscal Times
  • Play

    'Great Rotation' Into Stocks Runs Its Course

    Investors have been putting money back into bond funds as interest rates have unexpectedly dropped this year.

    Morningstar
  • Can Sears Close 2,300 Stores?

    In a widely publicized note to investors, Gary Balter of Credit Suisse said that it is best that Sears Holdings Corp. (SHLD) close its Sears and Kmart locations while they, and the inventory they sell, still have value. Sears Holdings operates about 2,350 stories. Sears is generating negative…

    24/7 Wall St.
  • The Steps To Success

    Who is the one person who has had the biggest impact on your life?

    AdChoicesstrayerSponsored
  • Rivals dash to support Apple Pay for fear of losing out

    Apple Pay preserves many existing relationships while inserting a new dominant player - itself - as kingmaker. The 800 million Apple users who have already connected credit and debit cards to iTunes accounts. "Apple's approach appears to be collaborative with traditional payment networks, instead…

    Reuters
  • 'Bubble in everything, everywhere': Marc Faber

    Even after the Dow (Dow Jones Global Indexes: .DJI) and the S&P 500 (^GSPC) closed at new all-time highs, closely followed contrarian Marc Faber keeps sounding the alarm. Faber has long argued that the Federal Reserve's massive asset purchasing programs and near-zero interest rates have inflated…

    CNBC
  • Pilot Delays His Flight for Alibaba Debut, Nabs Shares at $94

    Cory Frugé, a commercial airline pilot, first learned of Ltd. about four years ago when he set out to build a private runway on his property in Iota, La. He needed to buy lighting for the runway and in his search for affordable solar-powered lights he stumbled on Alibaba's website. On Friday…

    The Wall Street Journal
  • Here's What Mark Cuban Wishes He Knew About Money In His 20s

    AP Mark Cuban is the owner of the Dallas Mavericks. Billionaire investor and entrepreneur Mark Cuban is generous with his advice. When we asked him what he wishes he'd known about money in his 20s, he said:

    Business Insider
  • Stock Market Blogger 'Jesse Livermore' Is Calling The Top

    On Friday, Alibaba is set to make its debut on the NYSE in the largest IPO ever.  Jesse Livermore, the pseudonymous blogger of Philosophical Economics, on Thursday night noted that in 2012, Facebook's IPO marked the market bottom for the year, and sees Alibaba's debut as potentially marking the top…

    Business Insider
  • Can I Actually Rent-to-Own a Home?

    For them, a rent-to-own arrangement can appear to be an attractive option. During that time, the landlord/seller sets aside part of each month’s rent payment into an escrow account. When the lease is up, provided the payments have been made in a timely manner, the renter can use the money in the…

    Credit.com
  • Wondering How You Could Save on Home Insurance?

    Get a quote from Farmers Insurance and discover how you could save. Speak with an agent to get the knowledge you need to make an informed decision.

    AdChoicesFarmers InsuranceSponsored
  • Yahoo rakes in another jackpot from Alibaba's IPO

    Yahoo is making amends for years of blundering with one smart move: an early investment in Alibaba Group that has turned into a multibillion-dollar boon. The latest windfall came with Alibaba's record-setting IPO completed late Thursday, in which the Chinese e-commerce giant raised $25 billion.…

    Associated Press
  • Play

    A Favorable Prognosis for This Pharma Stock

    Recent clinical success in cystic fibrosis positions Vertex as a dominant player in this attractive rare-disease market.

    Morningstar
  • 3 Chinese Stocks That Are Better Bargains than Alibaba

    All eyes are on Alibaba Group Holding (BABA) as the Chinese e-commerce giant makes its U.S. Alibaba dominates Internet sales in the world's most populous nation, moving more merchandise than Amazon.com (AMZN) and eBay (EBAY) combined and serving up healthy profits. When the stock begins trading on…

    Kiplinger
  • Why you shouldn't buy Alibaba: Pros

    Alibaba (BABA) shares hit the market Friday amid much hype, becoming the biggest initial public offering in U.S. For one, since it's an IPO, it's probably overpriced, Barry James, president of James Advantage Fund, told CNBC. "When you look at initial public offerings, 80 percent of them lose money…

    CNBC
  • Lacker Says He Opposes Fed Plan to Hold Mortgage-Backed Assets

    Federal Reserve Bank of Richmond President Jeffrey Lacker said he couldn’t fully support the central bank’s revised exit strategy released this week because he opposes a measure to hold mortgage-backed securities. “I believe this approach unnecessarily prolongs our interference in the allocation of…

    Bloomberg
  • 10 Stocks Trading Under $10 With Huge Upside Potential

    Ballard Power Systems Inc. (BLDP) has been around forever as a fuel cell play. DryShips Inc. (DRYS) was started as Buy with a $5 price target at Deutsche Bank in a late-Monday call. The Deutsche Bank research on the sector was very positive, with 2015 expected to be a solid year for growth across…

    24/7 Wall St.
  • Often Overlooked Method to Pay Off Mortgage

    If you own a home and pay for a mortgage, you could reduce your payments by an average of $4,100 a year. Here is how it works.

    AdChoicesRateMarketplaceSponsored
  • At a Glance: the business dealings of Jeb Bush

    Jeb Bush entered the Florida governor's mansion in 1999 with a net worth of $2 million, a relatively modest fortune compared with others in the Bush family. Within months of leaving office, he started a consulting firm, registered as a broker for Lehman Brothers and joined a number of corporate…

    Associated Press