Bubbles and the corruption of risk

I have previously warned that the combination of the demographic avalanche of retiring baby boomers, low interest rates and a disproportionately large amount of their wealth in cash would mean that stocks and property would continue to rise for a while. I call it ‘The Boom We Have to Have.’ But like all booms, this one will also bust.

These conditions, especially low rates forcing a big part of the population into riskier products, corrupt investors’ sense of risk. Rising prices amid a wave of buying reinforces the behaviour of investors and their brokers who believe their thesis is correct.

New listings and credit point to problems

I am not alone in the view that at some point in the next six to eighteen months, there is a real chance that baby boomer retirement plans may sink thanks to their inability to avoid repeating the investment mistakes of their past. Stanley Druckenmiller is an American hedge fund manager, famous for being the lead portfolio manager for George Soros’s Quantum Fund. In 2010, Druckenmiller handed back the billions he had been managing for 30 years through his firm Duquesne Capital. He remains a noted philanthropist, keen golfer and speaker on the global investment and macroeconomic circuit.

Druckenmiller should be heeded. He observed that low rates have skewed peoples’ sense of risk, particularly in two markets – new share listings (IPO’s) and credit. He pointed out that 80% of companies listed in 2014 have “never made a dime”. In 1999, just before the tech crash, that number was 83%.

(As an aside, over the Christmas break, I read You Only Have To Be Right Once: The Unprecedented Rise of the Instant Tech Billionaires. Including Twitter, Facebook, Instagram, the book was a who’s who of the world’s biggest tech companies and the backgrounds to their stunning rises. But I couldn’t help noticing that all the references to billions had little or nothing to do with profits or in some cases even revenues. Some of the businesses discussed, which were sold for billions, not only had no revenue but no revenue model either).

Druckenmiller had another warning on credit markets. Last year, speaking on CNBC, Druckenmiller said, “When I look at credit … corporate credit is growing at a record rate, far faster than it grew in 2007. And S&P pointed out that 70% of debt issued has a B-rating or worse. To put that in perspective, in the ’90s, that number was 31%. Do you remember the hullabaloo in 2007 about covenant-light loans? Companies issued $100 billion of them in 2007, and 38% was B-rated. This year we’re going to $300 billion, up from $260 billion last year and $90 billion a year earlier, and 58% of them were B-rated.”

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