The current credit bezzle

 

With the bankruptcies of First Brands and Tricolor, there are clear signs that we are facing mounting credit issues. More importantly, we are seeing the classic Bezzle described by John Kenneth Galbraith in his book on the 1929 crash. We are not faced with a downturn in the business cycle. There is no recession; however, there is an exuberance that has been described by Minsky in his financial instability hypothesis. When overly optimistic views of the economy are coupled with extreme asset values, there is a higher likelihood that some will take advantage of the situation and cut corners, potentially committing fraud.

A review of the bankruptcies and new reports suggests that, in both cases, there was potential fraud or financial complexity that did not provide debtors with accurate information about the economic health of the firms. If we are seeing this under current healthy conditions, we can imagine more bankruptcies if asset prices fall. This is called the "febezzle" by Charlie Munger, referring to the false wealth created by high asset prices. If prices fall, the excessive wealth will quickly fall.

The key takeaway is that credit risk premiums should increase and investors should be paid more to hold risky debt.

John Kenneth Galbraith and the "bezzle" - It is a global issue

The bezzle and markets - Risks could be rising

Industrial policy thinking is back - Not clear that this is good

 

Marketcrafters by Chris Hughes is a quick read featuring stories of individuals who used government to shape market direction. In general, the stories are positive, yet some individuals used their power to bend policy in ways that had adverse market effects. The overall theme of this book is that effective industrial policies can influence markets for positive economic outcomes, whether in housing, monetary policy, international finance, energy, or crisis response. Hughes makes the case that good policy leads to good outcomes, but he also shows that bad policy can have severe negative consequences. Hence, a new industrial policy view will not be effective in creating a better economy. My takeaway is that industrial policy should apply the precautionary principle and be careful not to bend markets to your will, because the law of unintended consequences may lead you down a path worse than a market solution.

All bond hedges ae not the same

Most movements in the yield curve are parallel, so the correlations between different Treasury maturities and the S&P 500 will show strong co-movement. When the yield curve changes shape, likely due to a revision in monetary policy, there will be a dislocation in correlation co-movement. We are seeing this in the 2025 correlations. There is a positive correlation between 30-year Treasuries and the SPX, while there is a negative correlation for 2, 5, and 10-year Treasuries. We expect that these will converge in 2026 as the Fed stabilizes its monetary policy.

Is it always about momentum but need style/factor diversification

 

There is a bandwagon effect with the momentum factor. The momentum factor performance is closely associated with cumulative flows into an asset or asset class. Still, these strategies do not last forever, which is why an investor should diversify their sources of alpha.

The simple case is to match the fundamental and systematic components to achieve a smoother blended return. 

Money flows and market behavior will change, and it is hard to find these turning points, so the first pass for effective factor management is to use more than one factor and ensure they show natural low correlation.