BRICS Downgrades Portend Bond Market Illiquidity Gates

Goldman Sachs invented the BRICS concept to attract corporate finance clients. Enterprises that sought expansion to supposedly hot emerging markets now had a fun acronym to throw around their boardrooms. Emerging markets rode the BRICS coattails with eye-popping debt issuance. The world's debt explosion now faces an implosion, beginning with some BRICS members.

The S+P downgrade of Brazil's sovereign credit rating is another ill omen for the world's bond markets. The Petrobras downgrade also matters because that company's fate is inseparable from that of Brazil's national economy. Brazil ranks 69th out of 174 on Transparency International's Corruption Perceptions Index and 118th out of 178 on the Heritage Foundation Index of Economic Freedom. The poor rankings indicate that Brazil's national government cannot resolve its fiscal problems without a much more severe political crisis. Petrobras will not be out of the woods as long as the Brent crude price tests a multi-year low.

The other BRICS problems are obvious and endless. Beijing cannot prop its equity markets forever and will eventually run out of foreign currency reserves to sell. Russia's dependence on oil exports place it next in line behind Brazil and China for drawn-out political and economic drama.

Bond investors should recall US regulators' recent discussions of bond market gates that will prevent investors from liquidating their holdings. Endowment and pension fund managers are often confined to investment-grade bonds in accord with their investment policy statements. Sovereign credit downgrades will require money managers to sell their downgraded bonds as one developing country after another faces the credit ratings axe. The SEC's theoretical bond market gates will then suddenly become reality. Retail bond investors will be unable to sell anything as the market goes bidless.

It would be unfair to blame Goldman Sachs for the BRICS debacle. The rest of Wall Street is just as shortsighted as one marquee firm. Everyone who could have seen this coming chose to ignore default risks for emerging economies tied to low-value exports. Investors who sought higher yields in fixed income will be stuck with junk bonds when the gates slam shut.

The Haiku of Finance for 01/02/15

Petrobras trouble
State-run oil payoff charges
Carnival gone bad

Financial Sarcasm Roundup for 07/29/13

July went by pretty fast but not fast enough to avoid my sarcasm.  Nothing on the calendar escapes my bitter rants.

It's really cute that China will audit debt at all levels of its government.  I take this promise about as seriously as I took the bank stress tests in the US and Europe.  There's no way Chinese regulators will ever announce anything other than a clean bill of health to the public.  They liberalized bank loan requirements precisely because they plan to layer more debt on top of existing debt.

China isn't the only kid on the block that wants to continue their leverage binge.  Germany has assured Greece that it will not face further debt haircuts.  I can only guess at how ginormous the Fed's dollar swap lines with the ECB have now grown to make this promise possible.  Even Frau Merkel's iron rhetoric has softened.  Elite fear of asset destruction and revolution must be palpable in the halls of Brussels, London, and Washington.

Corporate earnings have declined, and I think they've probably peaked.  No way could profits at twice their historic percentage of GDP ever be sustained indefinitely.  I'm pretty sure I've said that on this blog more than once.  Mean reversion to 6% of GDP means an overshoot to the downside is likely before another upturn can take place.  People who work for a company listed in the S&P 500 need to update their resumes.

The IMF doesn't have to worry about whether the Fed will improve its transparency.  There is no way that is going to happen.  The Fed is not going to end QE until after hyperinflation destroys the dollar.  I could have told the IMF that but they never asked me, so instead they have to go wondering out loud in public.

Now it's Brazil's turn to make me LOL.  Brazil wants the IMF to exclude the debt owned by its central bank from formal government debt calculations.  That is about as irresponsible as a homeowner asking their credit agency to exclude their delinquent mortgage from their credit report because it can't be securitized.  Try running that argument past your home loan officer and see how fast they have security escort you out of the bank.  Brazil's pleading makes it clear that their currency isn't ready to serve as part of a central bank reserve portfolio no matter how robust their natural resource inventory looks.  At least they still have the next Summer Olympics going for them.

I'm not going to count on any of the above parties to tell the truth until real economic results are obvious even to the dullards running mutual funds and wealth management firms.  The irony of evolution is that folks with the most attractive pedigrees have become the least able to adapt to environmental changes.  Stupid losers deserve what they get for not reading my blog.