Poland Proves Best in Years Since Lehman: Riskless ReturnSimon Kennedy and Shin Pei
In the immediate turmoil following the 2008 collapse of Lehman Brothers Holdings Inc., Polish bonds might have not been the first possibility that came to investors’ minds when looking for profit.
They should have been.
Polish debt has delivered the best risk-adjusted return since the then-fourth largest U.S. securities firm filed for bankruptcy, followed by New Zealand debt and Bank of America Merrill Lynch’s Global High Yield Index, according to the BLOOMBERG RISKLESS RETURN RANKING. Each returned more than 10 percent when adjusted for volatility, according to an analysis of almost 200 securities, indexes and industries. By contrast, global stocks, as measured by the MSCI World Index, rose 2 percent.
It’s the last thing many investors would have expected in the dark days of five years ago, when Lehman Brothers helped trigger the worst financial crisis since the Great Depression and the deepest global recession since at least World War II. Those who profited rode on the backs of central banks that slashed interest rates and bought assets to save and then support economies and markets.
“Given that the world was looking at a depression with the possibility of serial defaults, a better market risk adjustor at the time would have been the probability and extent of permanent loss,” said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. in Newport Beach, California. “If you knew then what you know now, you would have seen governments and central banks successfully doing whatever it takes to normalize markets and, moreover, persisting with policy experiments thereafter.”
The less prescient -- that is, most investors -- fled risky assets. They did so as they fretted more banks would fold or companies wouldn’t be able to fund themselves, said Stuart Stanley, a fund manager at Invesco Asset Management in London. The BofA Merrill Lynch index fell 1 percent in the rest of 2008 after the bankruptcy, the weakest performer of those tracked.
“What you had in retrospect was a dramatic overreaction to risk markets,” he said. “The economy finding support and rates falling dramatically all made high yield attractive after 2008.”
The victim of a credit crunch whose seeds lay in excesses such as the U.S. subprime mortgage market, 158-year-old Lehman Brothers filed for bankruptcy on Sept. 15, 2008, amid $613 billion in debt. A recent study published by the Federal Reserve Bank of Dallas estimates that in the U.S. alone, the financial crisis may have wiped out as much as $30 trillion of wealth.
For investors, it marked the start of a “terrifying followed by enthralling” period, said Ewen Cameron Watt, London-based chief investment strategist at the investment institute of BlackRock Inc., the largest asset manager. Markets initially froze before policy makers cut taxes, bailed out banks and pumped liquidity into the financial system.
On a risk-adjusted basis, bonds have proved a winning bet since the bankruptcy filing. Buyers of Polish government debt recorded returns of 12 percent and those who added New Zealand bonds to their portfolio logged an 11 percent return. The returns are in local currency and don’t include the impact of exchange-rate swings.
The debt of South Africa, the Czech Republic, Finland and Hungary returned more than 7 percent. U.S. debt over the period returned 3 percent while crisis-lashed Greece’s debt was the worst performer among bond markets studied, losing 1 percent.
Stocks showed a similar pattern. The ability of Asia’s emerging economies to outpace the developed world and power the globe out of its slump was reflected in the 9 percent climb by the FTSE Bursa Malaysia KLCI Index and the 7 percent increase in the Jakarta Composite Index in Indonesia.
By contrast, the U.S.’s Standard & Poor’s 500 Index and the Stoxx Europe 600 Index both returned about 2 percent.
Investors found the courage to seek returns in far-flung markets once they were reassured by central banks, said Stephen Jen, co-founder of hedge fund SLJ Macro Partners LLP in London. Repeated rounds of bond buying gave investors security and then encouraged them to seek higher returns elsewhere, buoying other assets.
Bank of America economists estimate policy makers have executed more than 500 interest rate cuts since June 2007 as benchmarks in the U.S., Japan and Europe fell close to zero. The Basel, Switzerland-based Bank for International Settlements calculates asset-buying has increased the size of central bank balance sheets to more than $20 trillion, the equivalent of about 30 percent of global gross domestic product and up from about $10 trillion at the start of 2008.
“Anything that is influenced by the Fed got exceptional support,” said Jen, a former International Monetary Fund economist. “It inserted a wedge between fundamentals and market prices and every time this wedge came under pressure, the decision was taken to reinforce it.”
The market for high-yield bonds, with securities rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s, also turned out well. The BofA Merrill Lynch index returned 11 percent and its Global Corporate and High Yield Index 7 percent.
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period of time, increasing the potential for unexpected losses compared with a security whose price moves at a steady rate.
The divergence in stock performance between emerging and developed markets mirrors a split in the world economy, which has grown 20.9 percent from 2008 to 2013, based on International Monetary Fund data and projections. Advanced nations expanded 6.9 percent, while emerging markets swelled 51.5 percent.
China’s GDP has grown 100 percent, according to IMF data. By comparison, the U.S. economy is just 14 percent bigger and Japan’s 6 percent. Even worse, the GDPs of Germany, France and the U.K. are still smaller than five years ago, while Greece’s has shrunk 29 percent.
The rise of developing nations meant commodities also performed well before reversing gains recently. Palladium was the asset of choice with returns of 5 percent over five years, beating gold’s 3 percent and silver’s 2 percent.
When it comes to top-performing industries on a risk-adjusted basis, the Bloomberg World Internet Index, featuring companies including Amazon.com Inc. and Google Inc., gained 7 percent since September 2008. Bloomberg indexes for biotechnology, global agriculture and beverages all rose 6 percent.
A gauge of alternative energy stocks, including Areva SA and Nordex SE, fell 2 percent. As for banks, the NYSE Arca Securities Broker/Dealer Index has gained less than 1 percent and the Bloomberg Europe Banks and Financial Services Index has dropped 1 percent since 2008.
For Jim O’Neill, the former chief economist at Goldman Sachs Group Inc., a major trend since 2008 has been the U.S.’s pivot toward greater exports and China’s shift away.
That is reflected in a halving of the U.S. current account deficit since 2005 to about 3 percent of GDP and a shrinking of China’s surplus to 3 percent from 10 percent in 2007. The dollar’s 6 percent slide against the Chinese yuan was the worst performance among assets examined.
“China is becoming the old U.S. and the U.S. is becoming that old China,” said O’Neill, who coined the term BRIC to describe the major emerging market economies. “That started the night of Lehman Brothers. China realized that its day of being a glory exporter was finished. Moving to a world which is less imbalanced is a fundamentally healthier place.”
Harvard University professor Kenneth Rogoff predicts the repercussions in economies and societies will endure. Unemployment rates in cash-strapped Greece and Spain are now above 25 percent with youth joblessness even higher, leading to political disturbances and greater support for populist politicians.
“You’re going to have huge lasting social and political effects which are difficult to know,” said Rogoff, co-author of a bestselling study of 800 years of financial crises.
While the Fed was right to provide liquidity in the immediate aftermath of Lehman Brothers, it went too far in subsequent quantitative easing, said Stanford University professor John Taylor. Some markets have become overly reliant on its support, which may also encourage risk-taking in the future.
“I have had concerns with respect to the impact on markets,” said Taylor, a former U.S. Treasury official, who questions how much asset purchases have done for the economy.
An irony is that five years on, some of the financial and economic trends spawned by Lehman Brothers are starting to reverse: Growth in developed nations is strengthening just as it slows in emerging markets, the Fed is considering a tapering of stimulus and bond yields are climbing worldwide.
The Bank of America high-yield index has gained just 1 percent this year, Poland’s bonds are flat and New Zealand’s are down 1 percent. Among the biggest gainers of 2013 so far are Bloomberg’s aerospace industry gauge and the NYSE Arca index, which have both risen about 3 percent on a risk-adjusted basis.
“If central banks start to move to an inflection point the market needs to anticipate that normalization,” said Jen at SLJ, whose outlook is negative on emerging market and high-yielding assets.