It’s been a banner year for stocks already. In fact, if we could just shut this whole thing down for the next 10 months, we’d be looking at double-digits returns on the S&P 500 SPX, -0.11% 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.
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.’