Markets are getting slammed on Friday with stocks tanking, oil prices tumbling, and high yield bond spreads blowing out.
The sell-off in the high yield (aka junk) bond market comes in the wake of a Third Avenue Management telling clients that they would not allowed to redeem money from a bond fund due to, among other things, “a general reduction of liquidity in the” bond markets.
“Unfortunately I believe the meltdown in High Yield is just beginning,” Carl Icahn warned in a tweet.
For months, Icahn has been warning trouble was coming to the financial markets.
In a video titled “Danger Ahead,” the billionaire Wall Street veteran lays out the major problems coming out of both Washington and Wall Street to argue that what’s coming next will be “very dangerous and could be disastrous.”
He started by explaining why Donald Trump had become so popular in the presidential polls. It boils down to a frustrated American public, angered by how little reform has been passed to stimulate growth. Two key issues Icahn argues must be addressed are the carried-interest tax loophole for investors and the exorbitant repatriation tax that discourages multinational companies from bringing their profits back to the US.
For the financial markets and the economy, Icahn says the core problem is the Federal Reserve and its ultra-easy, zero-interest-rate policy. While Icahn credits the Fed with getting us out of the most recent crisis by using these policy tools, he also argues that it was the Fed that got us into that crisis to begin with.
Icahn observed that while low rates are intended to boost business investment, in reality they have actually led corporate managers to employ financial engineering and accounting shenanigans to boost earnings per share.
Icahn offers a very straightforward and chilling summary of what he believes to be an unsustainable and fragile set of circumstances that are propping up the stock market. And in the end we’re left wondering whether we could repeat what we saw during the financial crisis. Or worse.
Below is a summary of Icahn’s warning about the stock market.
'What they're doing with the money is almost perverse,' Icahn said.
Rather than using cheap financing to invest in business and equipment, Icahn observed, companies are engaging in financial engineering to boost earnings and ultimately their stock prices.
Instead of investing for growth, companies will just use money to buy other companies to create the perception of growing earnings.
Icahn says it's like taking steroids. Everyone's happy to see an athlete jump high. But that type of earnings growth is not sustainable.
Now, companies like Apple can and should buy back stock because they're sitting on hundreds of billions of dollars in cash and not a lot of debt.
It's a problem when companies with little earnings and lots of debt buy back stock. And yet everyone looks at earnings go up quarter-to-quarter and your stock goes jumping up.
The Fed's balance sheet has mushroomed. This is money that has flooded the markets and crowded out the investor class.
All of this money in the risky high-yield-bond market has helped fuel a boom in mergers and acquisitions.
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