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4 Dangers Icahn Is Worried About; Stay Away From Bonds
Aspire, Thought Leaders | 05 October 2015
By: Lim Si Jie
Articles (169) Profile

Billionaire investor Carl Icahn has a stern warning: Trouble is brewing in the financial market. The activist singled out four dangers that the market is facing as he warned about the Federal Reserve’s zero-interest rate policy and high-yield bonds.

1. The Fed’s Low Rates Creating Bubbles

Source: Carl Icahn's "Dangers Ahead" video

Icahn believes that stocks could go down “a lot more” as the market comes to grips with bubbles exacerbated by the Fed’s zero interest rate policy.

He warns that major market upsets of the past could be seen again, perhaps even worse, as the Fed has been keeping interest rates too low for too long. Summing it all in an analogy: “It’s like giving somebody medicine and this medicine is being given and given and given and we don’t know what’s going to happen – you don’t know how bad the end of this is going to be. We do know when we did it a few years ago it caused a catastrophe, it caused ’08 ‘.” said Carl Icahn.

2. Inorganic Growth – Merger & Acquisitions

“Low rates has led the market to a situation where it creates earnings mirage,” said Icahn. Rather than using cheap financing to invest in machinery and their workers to make them more productive, Icahn pointed out that companies are engaging in financial engineering in their efforts to boost earnings and ultimately their stock prices.

This means that instead of investing for growth, companies are using cheap financing to acquire other companies to create the perception of growing earnings. Icahn likens this to taking steroids where everyone is happy to see an athlete jump higher. However, such earnings growth is not sustainable.

3. Earnings Mirage – Shares Repurchase

Some companies are using the cheap finances to repurchase shares off the market. Icahn states that while shares buyback is a short-term fix, it will weaken a company’s balance sheet.

Financially healthy companies like Apple can afford to and should buy back stock because they are sitting on loads of cash and does not hold much debt.

However, companies with small earnings and lots of debt are also repurchasing their shares, which Carl Icahn believes is a problem. It creates the wrong impression that earnings per share are growing when the absolute value of the company’s earnings is stagnant or even decreasing. This encourages managers to keep ploughing more investments into the stock market. “But what is going to happen in that market, and who is going to buy your stocks when those earnings are coming down?”, questions Carl Icahn.

4. Risky High Yield Bonds Oversold 

Icahn said the growing Fed balance sheet has left middle-class investors with “nowhere to go but the stock market, or those high-yield bonds” in order to seek reasonable returns. The balance sheet has “mushroomed from $1 trillion to over $4.5 trillion,” Icahn said, describing this as an “almost unbelievable move.”

According to Carl Icahn, high-yield bonds are extremely risky but yet they are being sold “en masse” to the public, whom he believes don’t really understand what they are buying. The growth in the high yield bond market has been incredible, with the junk bonds and leveraged loan market now worth $2.2 trillion, up from $1.2 trillion five years ago.

Carl Icahn predicts that “if and when there is a real problem in the economy, there’s going to be a rush for the exits”. Investors who hold these junk bonds will find that there is no market for them.

Investors Takeaway: Understanding Your Investments

Investors holding onto bonds or deciding to invest in bonds should ensure that they understand the possible risks entailed in the bond. Bonds with high yields are usually riskier than government backed bonds due to the greater risks in the bond issuer. Bond investors should also take note of the liquidity of the bonds to ensure that they are able to offload should there be a need.

Stock investors should compare traditional stock indicators like PE multiples with other indicators such as EV/EBITDA to ensure that companies are not financially engineering their ways to create artificial earnings growth.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.


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