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The Giraffe in The Coal Mine 

April 9, 2018

By Bill Kelly, CAIA Association

What’s a few dead canaries amongst friends, or maybe miners? Historically, it has meant a highly toxic atmosphere and a time to immediately retreat to safer ground. In the autumn of years since the GFC, the financial markets have witnessed plenty of canary-like warnings, but most have been shrugged off under the TTID and FOMO Twitter hashtags. Well, when the canary has ceded the early warning job to a giraffe who in turn goes belly-up, maybe it is time to emulate those clever miners.

The giraffe in question here is named Geoffrey who was the goofy, but loveable, brand mascot for Toys “R” Us. An interesting story in the current edition of Barron’s shows that Geoffrey had been sick for a while, and that perhaps there is a broader contagion going on in the current cycle of the bond market. Liquidity has been plentiful and cheap, and the issuers have feasted away. Around that buffet table you will see the sovereign borrowers, corporate treasurers, private capitalists, and even the garden-variety consumer. The levels of debt across that spectrum are high by any relative or absolute measure, and the Triple-B space is just one sign post where the market now stands at $2.5 trillion or a cool 3.6 times larger than it was at the GFC.

The demise of Geoffrey was more classic than unusual, and even while the current POTUS is blaming Amazon for much that ails the basic retail model, this was not the typical “clicks-over-bricks” story. The funny thing about all debt is that it eventually needs to be repaid or at least refinanced. The amount of available liquidity in the market has its limitations and when central banks start flashing very real signs that they don’t want to play the game as much as they once did, we should take note. Couple that reality with rising rates, and FOMO in the bond market quickly becomes FONGMMB or “fear of not getting my money back.” Borrowing costs go up, debt service as a percentage of EBITDA soars, covenants bust, a more opportunistic set of lenders gets closer to the front of the line, and giraffes die.

If Geoffrey’s death is giving you flashbacks to 2008, heed them well. The movies, books, and archived articles are numerous, and blame was very generously spread around, but make no mistake about the fact that this was ultimately a crisis due to a lack of liquidity. Anyone who was long debt (or most financial assets and real estate, for that matter) got crushed, but the ones who were long liquidity now had their own version of a wide-eyed feast with multiple re-entry points where opportunities were quite literally hanging on the bargain basement rack.

Market timing is never a winning strategy and there are opportunities and entry points within every tick of a cycle. In this current environment, there are no short cuts or low hanging fruit even if you have the neck (or knack?) of a giraffe to reach for those higher limbs. Do your homework and make research and due diligence your friend. You can start here and perhaps learn why your best fixed-income return option might be more a function of equity-like appreciation rather than a fixed yield.

Seek diversification, education and know your risk tolerance. Investing is for the long term.

Bill Kelly has been CEO of the CAIA Association since 2014.