As the world markets, mature and emerging, went through the turbulent transition from low rates by the Federal Reserve to “a measured and consistent rise,” most bond markets suffered. In fact all bond markets suffered. The reverberations of each pronouncement by Federal Reserves chieftain, Alan Greenspan, are felt all over, in commodities, equities, but most importantly, in fixed income securities. This is a universal occurrence, except for Lebanon. Lebanon has been outstanding at being exceptional in almost every conceivable measure over its history. In this case, while the entire curve of interest rates gyrated all over the world, Lebanese bonds remained unmoved. In fact, expecting a big hike in Lebanese Republic rates (move down in price), I called some of my contacts a day after some inflation numbers in the US rattled every market from Kuala Lumpur to Sao Paolo. Guess what? Lebanon bonds were unchanged.
It is important to place in context the latest two years of bond action worldwide. The fall of the Lebanese bond yields came within an environment of intense global reflation and increased liquidity, and in most cases this environment benefited emerging markets and lower quality corporate issues. This drop in risk aversion, or increase in appetite for risk came on the heels of a huge increase in liquidity and as a rebound from the bubble meltdown in the US. Still, it was unprecedented in magnitude and timeframe. Lebanese Republic bonds were up more than 25% in a year, which represents equity type returns, and more importantly, without any improvement in fundamentals besides a last minute donor conference in Paris in November 2002. But in effect, the fiscal deterioration continued in Lebanon, political polarization increased and placed the entire system in a state of near paralysis, pushing out privatization, reform and just about anything else promised at any time. Still the bonds performed well.
Previous articles have addressed the tightness of the Lebanese bond market. The sovereign bonds are held almost entirely by local banks. This derived from a post-Russian crisis aversion to international bonds, and most importantly from the incestuous fiscal ménage between the banks and the Lebanese treasury, with banks continuing to prefer local risk. The market is illiquid, and held by a few institutions, and this has provided the market with a sort of immunity from international tremors. By definition, one should be wary of rigged markets, especially where the exit door is bar locked and volume is thin. This has been the case for Lebanon Republic bonds for more than two years now. There is no trading (for all practical purposes there is one holder: the banking sector) and a complete disregard for economic and budgetary time bombs as well as any international benchmarks. And herein lies the real problematic issue with the current pricing and interest rate structure of the bond market. It is unrealistic and expensive. It is unwise to go back and dwell on the decaying political system, the ballooning deficit, and the lack of credible economic policy. This would be tantamount to “shooting at the ambulance.” The regime and its failings are too easy a target. What we want to look at, in measured objectivity, is whether Lebanese bonds are safe for individual investors.
There are obviously many parameters in the decision to buy a bond, and they range from income needs, duration, potential capital appreciation in the case of depressed bonds, and of course alternatives. In a global market where individuals have a palette of choices and vast information on ratings, risks and opportunities, it is important to look at alternative bonds within similar risk factors.
To simplify the panorama, let us compare Lebanese Eurobonds with those of Turkey and Brazil. It is a broad enough geographical spread and in terms of economic maturity they lie at different points on the curve. Looking at the 2011 bonds this is the matrix of yields and spreads. What is key to bear in mind here is that while Lebanon is rated B-, both Brazil and Turkey are rated higher at B+. So the table should be even more mind-boggling:
Brazil 2011 10%
Turkey 2011 8.05%
Lebanon 2011 7.59%
According to those rates, one would think that Lebanon had a better rating, or better political climate, or better economic and fiscal fundamental. Wrong.
This represents an anomaly, especially in a global rising interest rate environment, and private investors wishing to remain in sovereign bonds are better served by looking at alternatives. There is no justification, besides the illiquidity and tightness of the market, for Lebanon to yield 240 basis points less than Brazil despite a lower rating. It is confounding that local institutions have so much risk concentration in Lebanese paper, lack of diversification would in other places be considered a point of vulnerability.
Lebanon bonds are trading in an “if” environment: if Paris II was respected; if the government had a clear plan for restoring balance and confidence; if the risk of external shock was minimal; and more staggering, if Lebanon had a clearer path than Brazil or Turkey. After the hits taken by many Lebanese in the devaluation (s), and the collapse of foreign markets, and the regional turbulence, caution over patriotism should prevail when it comes to Lebanon Republic bonds. With the real estate market in a state of Gulf driven irrationality, the economy stuttering, and the political environment infested, private investors ought to look at alternatives or wait for a significant event or back up in interest rates to reinvest.
In a globally unstable environment, and a rising rate trajectory, an investment in bonds has had a tendency to turn into financial bondage in many emerging and submerging economies.