Perhaps we’re overdoing the quotes from Mastering Market Cycles (almost done), but, my!, the book absolutely speaks to what we’re seeing in current general conditions, in investor psychology and, most concerning, in the debt markets.

Below is the author remembering the period leading into the 2008 Great Recession (the lines I bolded had me thinking about my quote from earlier today). The parallels to what we’re seeing in today’s collateralized loan obligations, leveraged loans, etc., are — to put it mildly — concerning…


Note: Before you read on, I want to emphasize that — despite the extent to which we’ve been expressing our concerns herein of late — we are not making a prediction, we’re simply assessing current conditions. And they demand a careful investment approach going forward:

“All you really had to do in 2005–07 was make the following general observations:

• the Fed had reduced the base rate of interest to very low levels in order to ward off the depressing effects of the tech bubble’s bursting, as well as concern over Y2K;

• because of the low yields available on Treasurys and high grade bonds, as well as the disenchantment with equities that had resulted from their three-year decline in 2000–02, investors were eager to put money into alternative instruments;

• investors had shrugged off the pain of the collapse of the tech bubble in 2000 and the telecom meltdown and corporate scandals of 2001–02;

• thus little risk aversion was present (especially in areas other than equities, which remained out of favor), rendering investors generally eager for investments in exotic, structured and synthetic instruments; and

• as a result of all the above, the markets were wide open for the issuance of low-quality debt, poorly structured instruments and untested alternatives.

These were our observations, and it was the last that most called our attention to the negative trends that were afoot. It felt like there wasn’t a day on which either Bruce Karsh or I didn’t visit each other’s office to complain about a newly issued security, saying, “It shouldn’t be possible to issue a piece of junk like this. The fact that it is means there’s something wrong with the market.” Those risky deals told us fear, skepticism and risk aversion were insufficient, and greed, gullibility and risk tolerance were in the ascendency. The implications of this combination are never good.

All the points noted here were obvious and not subject to debate. All that mattered is whether you made these observations and drew the appropriate conclusions.”

“….if you made the observations just listed, you likely would have concluded, as we did, that it was time to reduce the quantum of risk in your portfolio. That’s really all it took.”

Here’s from the earlier post I referenced above, read it, then read again what I bolded above:

“It’s risk-on in the leveraged loan market as the prices on Single B rated loans rally and ease the way for more riskier deals. Investors are now getting paid 1.78 points more on Single Bs than on higher-rated Double Bs, which is the lowest premium in about six months, according to Credit Suisse Leveraged Loan indexes.”  –Bloomberg

Now, to bring it all together, read again our October 31 post subtitled Absolutely, There Is A Bubble.