There are now more than $10 trillion worth of negative yielding government bonds in the world. More astounding still, there are over $380 billion worth of negative yielding corporate bonds! Imagine that. Paying to lend your money to a for-profit enterprise. Why would you do that?
If the bond market were a geological feature, it would have to be the San Andreas Fault. Or, perhaps, the Yellowstone Caldera. If you’re not familiar with either of them, all you really need to know is this: they are cataclysmic accidents waiting to happen. It’s not a question of “when.” It’s a question of “if.”
Financial markets are not tectonic plants. And markets can defy what feel like the forces of nature for a long, long time. I’m not saying the bond market has to blow its top. But even in financial terms, the secular bull market in bonds defies expectations. How long can a bull market last when you have over $10 trillion in sovereign debt with a negative yield?
It’s not a trivial or rhetorical question. In his latest edition of The Fleet Street Letter, investment director Charlie Morris reckoned that if indeed you see rising official US interest rates later this month, it’s not a good sign for bonds. It might, however, be a good sign for stocks, as investors move out of an overcrowded bond market and into some of the undervalued shares (those lagging the growth stocks the last 18 months).
I’ll leave the equity strategy to Charlie and Tim Price. But yesterday’s decision by the European Central Bank (ECB) to buy corporate bonds beginning 8 June could, according to one analyst, have the opposite of the intended effect. Rather than stimulating lending and growing the real economy, it could blow up the bond market and then the real economy.
He didn’t put it exactly that way. But Suki Mann, the credit strategist at creditmarketdaily.com, said basically what I said yesterday. ECB bond buying crowds out investors. Think of the corporate bond market like a nice restaurant you want to take your wife to at the weekend. You book a table, dress up nicely, look forward to a nice night out, take the train into central London, and wait in the queue… only to be shouldered aside by Mario Draghi.
Draghi and his entourage barge in, commandeer all the tables, and eat all the good food. Then they belch, tell you it’s for your own good and ask you to pick up the bill. But you’re still hungry. It’s off to Brick Lane for you, where you’ll wait in the queue again to have a curry and beer in the wee hours of the night.
High-risk investments are not like Indian food. But, all dining metaphors aside, if the ECB action pushes investors into taking on more risk by buying longer-dated bonds, Mann says it risks a day of reckoning. It “risks causing a systemic financial crisis when the market eventually turns.”
His words, not mine. But the key phrase is “when the market eventually turns.” Negative rates risk the turning point in markets, because it simply doesn’t make sense to own negative yielding bonds unless you’re front-running the central bank for a capital gain. Most normal people don’t do that.
By “normal” I mean people who are jealous of their accumulated capital, don’t want to lose it, and try to grow it through prudent risk assessment. The fact that central banks are trying to ruin these people – the attack on your savings I mentioned yesterday – shows you how mad they are. And frankly, how malevolent, unethical, and immoral.
If you like your bond market analysis without Old Testament fire and brimstone, Mann put it this way in a note to clients quoted in today’s Financial Times:
After dumbing it all down to zero, the ECB will look to drive it all into negative territory. That’s not just government bond yields out past 10-years likely being in negative yield territory, but the next step will be for them to further savage corporate bond yields. We already have a sizeable chunk of corporate paper offering negative yields. Pushing this into longer-dated illiquid non-triple A, “non-safe as houses” paper is so risky and another unprecedented move.
At the risk of beating the bond horse to death, let me turn to the bond king himself: Bill Gross. Writing from his coastal fortress in California, the Janus Capital guru says the 40-year bull market in stocks and bonds is either a “grey” or “black” swan event that “cannot be repeated.” You can read the whole thing here. Or you can read this excerpt:
Since the inception of the Barclays Capital U.S. Aggregate or Lehman Bond index in 1976, investment grade bond markets have provided conservative investors with a 7.47% compound return with remarkably little volatility. An observer would be amazed, as was I, at the steady climb of wealth, even during significant bear markets when 30-year Treasury yields reached 15% in the early 80’s and were tagged with the designation of “certificates of confiscation. But as bond prices were going down, the higher and higher annual yields smoothed the damage and even led to positive returns during “headline” bear market periods such as 1979-84, or more recently the “taper tantrum” of 2013. Quite remarkable, isn’t it? A Sherlock Holmes sleuth interested in disproving this thesis would find few 12-month periods of time where the investment grade bond market produced negative returns.
Gross goes on to make the case that this golden age for bonds – for selling debt – is over. If he’s right, it’s going to have massive consequences for investors. Is he right?
Nobody knows. But wait long enough and you’ll find out. Wait too long and you could get wiped out.
Category: Economics