The financial media is nothing if not predictable. Barron’s didn’t even wait for the ink to dry on the Dow Jones Industrial Average’s 20,000 print before declaring in a new cover story: “Next Stop Dow 30,000.” Barron’s argument is that “[t]he Dow hitting 20,000 was no fluke. Today’s stock prices are well supported by corporate earnings and economic growth. In fact, if President Trump can avoid stumbling into a trade war – or a real war – the Dow could surpass 30,000 by the year 2025.”
Leaving aside that this National Enquirer-style headline is little more than a desperate attempt to pump up readership and is followed by an extremely thin article lacking any analytical substance whatsoever, let’s take a serious look at Barron’s claims that corporate earnings and the economy are strong. You can wipe the rear end of a cow with these claims.
Then, let’s take a look at the one sector that hasn’t bought into the hype – and how you can profit.
While all eyes are on interest rates in the Treasury market, an even more important global interest rate recently breached a key level for the first time since the financial crisis: the London Interbank Offered Rate (LIBOR). On December 29, 2016 LIBOR hit 1% for the first time in seven-and-a-half years.
I wrote back in October of last year, when LIBOR had reached 80 basis points, that a move up past 1% could spell trouble for the credit markets. We have now reached that point and are starting to see signs of strain on which we need to keep a close eye.
LIBOR is an uncannily accurate thermometer that measures the banking industry’s health: in normal times, low rates mean banks are doing well, while higher rates indicate reduced public confidence and a struggling industry. Right now, we are not living in normal times and it is more difficult than in the past to determine how to read market signals such as LIBOR. Nonetheless, LIBOR remains an incredibly important global benchmark and its rise will meaningfully increase borrowing costs across the global economy.
Corporate credit quality is deteriorating not only among junk borrowers but among investment grade companies that borrowed tens of billions of dollars to pay dividends and buy back overvalued shares. While the inability to earn a decent return on capital in fixed income markets poses enormous challenges for investors, outright losses are far more dangerous. And that is what they are facing if rates rise even modestly.
Here’s what to expect now that LIBOR has breached the 1% mark – and how you can profit.