The Credit Markets Drive the Stock Market

The following Brian Reynolds interview by RealVision highlights how important pension funds are for driving the credit markets & stock market.

A few notes from it:

  • pension funds are significantly underfunded & they roughly need to get about a 7.5% return to meet cashflow obligations
  • pensions tend to prefer the credit markets to the stock market & use leverage to drive further incremental gains over the yield on a particular bond
  • many companies issue debt into the hungry bond market & use the funds to buy back shares, goosing earnings per share by lowering the denominator with a lower share count
  • it is hard to outperform the stock market index with active management at scale & many active managers are short the market, driving further underperformance
  • it is much easier to outperform in bonds during a bull market by simply buying lower quality debts at higher yield, which works until it doesn’t.
  • the Detroit bankruptcy changed the actuarial assumptions for public pension plans because pensioners did eat a loss. thus state & local tax increases ramped significantly, which more than offset the much heralded Trump tax cut
  • market volatility dissipates & the market returns its grind ever higher until at some point pension plans ask to cash out of a particular issue & are unable to, which drives a rush for the exits.
  • the above sort of cycle has driven bubble after bubble. so far this century we have had bubbles in:
    • telecom / internet / information technology, which caused the Federal Reserve to lower rates, thus igniting
    • residential real estate / housing, which caused the subprime bubble crash after they began raising rates, which then led to large scale balance sheet expansion, which then led to a bubble in
    • commodities, in particular debt associated with oil fracking & then a commodity price decline, …
    • and now some sectors of commercial real estate
  • individual investors have favored ETFs over mutual funds, but largely that move has been a wash. most of the net buying of stock since the recovery has been from buybacks from companies.
  • he believes a while after yields invert there will be an LBO spree which will drive the final blow off top
  • in the next crisis pension plans are perhaps going to be more likely to receive a bailout than banks were in the last crisis
  • the pension-driven bubble cycle is likely only to end if we go from defined benefit pension plans to defined contribution pension plans

Leave a comment

Your email address will not be published. Required fields are marked *