The following is an amended version of the Sept. 29 Daily Contrarian. This briefing and accompanying podcast are released to premium subscribers each market day morning by 0700. To subscribe, visit our Substack.
Stocks rallied yesterday after the Bank of England said it would intervene in bond markets. The central bank will buy £65 billion worth of long-dated gilts at an “urgent pace” and postpone plans for quantitative tightening. The Wall Street Journal has as good piece that gets into the quandary the BOE was in. Apparently pensions were on the hook for holding derivatives tied to interest rates.
Bank of England logo (old)
Pensions, Derivatives, Systemic Risk
The BOE move was cheered by markets but it does raise questions. If pensions are behaving like hedge funds by betting large amounts of money on esoteric (and illiquid) interest rate swaps, then that would certainly introduce a level of systemic risk to the system.
If all that sounds familiar, it’s because it’s exactly what almost brought down the whole financial system in 2008. Except then it was banks trading these things, not pensions. (Okay, strictly speaking they were different instruments. But whatever, they were still derivatives. And yes, comparisons to 2008 are cheap AF. Still, this looks like an obvious similarity). They say regulators are always guilty of fighting the last war. Well, bank balance sheets are pretty clean these days. But pensions? Does anybody know what they’re even holding? And who are the counterparties?
The derivatives in question appear to be liability-driven investments, or LDIs. The size of this market? About $1.5 trillion (not a typo). This raises the very obvious question of what other pension funds in what parts of the world are trading these things.
We’ve cautioned for some time that once the whole market starts rolling over it could unearth problems that nobody had been anticipating. This is typical of market shifts of this size. Well here we go. So nice little bounce yesterday. But it would be pretty naive to think this issue is resolved and we can live happily ever after.
Jordi Visser, president and chief investment officer at Weiss Multi-Strategy Advisers, joins the podcast to discuss his reasons for optimism during this trying time for global financial markets.
Content Highlights
The environment is constructive for risk assets (2:26);
Focus has moved from inflation. Investors are too negative (3:50);
The Fed is raising interest rates. Inflation is coming down — a lot faster than people think (4:41);
What sectors and why? (9:53);
No, you don’t need unemployment to increase for inflation to come down (13:22);
The bullish case for biotech (15:12);
The blockchain will have profound impact on labor markets (19:42);
Background on the guest (25:13);
Clean energy and how that fits in (29:14);
Oil should move higher, but watch out for global trade (36:47);
Web 3.0 and cryptocurrencies: here too there are reasons to be bullish (39:48);
Beta has started to outperform profitability. A final reason to be optimistic (51:45).
