Why a bomb like the one that blew up markets in 2008 may be ticking right now

It’s been a banner year for stocks already. In fact, if we could just shut the whole thing down for the next 10 months, we’d be looking at double-digits returns on the S&P 500














SPX, +0.69%












 for 2019.

No complaints with that kind of annual performance.

Alas, it doesn’t work that way, and, needless to say, there are plenty of things that could go sideways before the bell rings in 2020. One of the risks could come from a familiar source: leveraged loans.

Read: Leveraged loans are in uncharted territory and that’s a big risk, Moody’s says

In our call of the day, Satyajit Das, a former banker who was once hailed as one of the world’s 50 most influential financial figures, says we could be facing a bomb similar to the one that exploded in the market a decade a year ago.

“Financial markets have short memories,” Das wrote in an opinion piece for Bloomberg over the weekend. “Of late, they’ve convinced themselves that collateralized loan obligations (CLOs) are much safer instruments than the collateralized debt obligations, or CDOs, on which they’re based and which helped precipitate the 2008 crisis. They’re wrong — and dangerously so.”

CLOs are similar to CDOs, in that each pools multiple loans to create synthetic, bond-like investments. It’s wonky stuff, but, basically, CLOs are set up to be a safer way to increase the leverage on a portfolio of debt. Instead of mortgages, subprime and otherwise, in CDOs, CLOs repackage corporate loans, and consumer credit, such as car loans.

“Nevertheless, many risks remain,” Das warned. “How safe or not CLOs are is contingent on several factors: the credit quality of the underlying loans — as judged by the risk of default and the extent of loss if there is a default — as well as the correlation between default and losses within the portfolio.”

There’s currently $700 billion in outstanding CLOs around the world right now, with annual new issues of more than $100 billion, similar to what we saw in the infamous subprime CDOs in 2008.


‘There are too many parallels to 2008 for comfort.’


Satyajit Das


Das said many aspects of the risks aren’t fully understood. For instance, the credit quality of loans packaged in most CLOs is below investment grade and the borrowers are highly leveraged, which increase the risk of higher losses.

“Investors assume that the portfolios are safer because they’re diversified,” he wrote. “Yet, relative to mortgages, corporate-loan portfolios typically are made up of fewer and larger loans, which increases concentration risk. Leveraged loans are highly sensitive to economic conditions and defaults may be correlated, with many loans experiencing problems simultaneously.”

As we’ve seen before, the nasty unwind can spiral out of control quickly in the face of a downturn.

“The risk is that CLOs will create adverse feedback loops,” Das said. “Falling prices, rising spreads and tightening credit availability will cause credit markets to seize up. Tighter credit will feed into the real economy, setting off losses, selling and price declines.” That’s when the fear contagion kicks in, he continued, as the financial position of banks is questioned and depositors refuse to fund banks.

“There are too many parallels to 2008 for comfort. Investors, many with uncertain expertise and weak holding power, have increased their exposure in the search for higher returns,” Das warned. “Built into this speculative episode, like its predecessors, is a euphoric flight from reality and a blindness to risks that continue to rise.”

Looks like that “blindness to risks” is about to spill over into Monday’s session, as stocks are setting up for a nice start to the week.

The market

Futures on the Dow














YMH9, +0.37%












 , S&P














ESH9, +0.34%












 and Nasdaq














NQH9, +0.57%












 are all pushing nicely higher, helped by talk that a trade deal could be right around the corner. Investors aren’t too keen on gold














GCH9, -0.79%












 this morning, with prices off around 0.8%. Crude














CLJ9, +0.82%












 is up and the dollar














DXY, +0.28%












 doesn’t seem to be paying any attention to Trump calls over the weekend for a weaker dollar. Check out more in Market Snapshot.

Overseas, Asia markets














ADOW, +0.05%












 turned in a positive performance, led by a strong rally in Shanghai














SHCOMP, +1.12%












 , while Europe














SXXP, +0.51%












 is sneaking higher.

The buzz

Lyft filed its IPO paperwork Friday, and now it’s poised to beat rival Uber to market, which means Lyft could be the first to talk to potential investors on a roadshow and have the opportunity to define its role in the ride-hailing industry as a company gaining ground on a larger competitor. Lyft plans to list under the ticker “LYFT.”

Elon Musk fired up Tesla














TSLA, -7.84%












 fans on Sunday afternoon when he tweeted about an upcoming unveiling of the new Model Y. In subsequent tweets, he said: “Model Y, being an SUV, is about 10% bigger than Model 3, so will cost about 10% more & have slightly less range for same battery,” and that “Detailed specs & pricing will be provided, as well as test rides in Y.”

Vale














VALE, -0.72%












 Chief Executive Fabio Schvartsman and other top executives of the Brazilian mining giant stepped down following pressure from authorities, signalling that investigators are zeroing in on the company’s leadership after the deadly collapse of one of its dams.

As Alexandria Ocasio-Cortez continues to get criticized on the right for her Green New Deal, the New York Democratic congresswoman made fresh headlines over the weekend for getting slammed by what would seem an unlikely voice: a former president of Greenpeace Canada.

The chart

See if you can spot the trend in this snapshot of the top-performing ETFs from last month, as spotted on Stockcharts.com.



Yes, the list is completely dominated by Chinese funds, led by this ETF














CNXT, +1.84%












 . Commodities also fared pretty well.

The quote
Bloomberg


Senator Rand Paul

“I can’t vote to give the president the power to spend money that hasn’t been appropriated by Congress. We may want more money for border security, but Congress didn’t authorize it. If we take away those checks and balances, it’s a dangerous thing” — Sen. Rand Paul, in a speech to a crowd of nearly 200 Republican officeholders and supporters at Western Kentucky University.

The economy

There’s plenty of data to chew on this week, with the headliner coming in the form of the February employment report at the end of the week. We’ll also get new home sales and housing starts along the way. As for Monday, car sales will trickle in throughout the day, with construction spending for December slated to be released at 10 a.m. Eastern. Also of note, Fed Chair Jerome Powell will speak on Friday at the 2019 Stanford Institute for Economic Policy Research Economic Summit.

The stat
Reuters


That’s it?

40% — That’s the percentage of voters in the latest NBC News/Wall Street Journal poll who say that they would re-elect Donald Trump next year. But “as long as these economic numbers look like this, that always keeps an incumbent president in the race,” one GOP pollster said of the results.

The tweet
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