Bonds
Alarms Ring As Markets Continue To Rise
Stocks and bonds saw increased prices last week, but it is leading many financial experts to sound the alarm, or at least let everyone know their hand is on the alarm and ready to pull.
Low-interest rates are fueling demand for bonds in safe havens, but many economists think people are paying too little attention to the relatively sluggish growth that the world economy is seeing.
Brexit and the world economy
Many think this rally is just a temporary jolt rather than a facet of a positive long-term economic outlook.
Laurence Fink, renowned economist, said that unless we see better than expected corporate earnings, the upturn in the global market would be reversed.
Although a large chunk was wiped off global markets in the immediate hours following Brexit, this was mainly just panic.
- Around $2.5 trillion was lost on June 24
- The pound fell to its lowest level in 30 years against the dollar
- The price of gold rose while other assets and commodities fell
Since then, a whopping $4 trillion has been added to global equities.
This is mainly thanks to the anticipation of central bank policy being one of increasing liquidity through quantitative easing.
This would be aimed at providing a stimulus to the economy.
Brexit is significant here because every single forecast made by economists prior to the vote was one of stagnant or reversed growth.
Though it hasn’t been the case so far, but the rhetoric from the Bank of England govern Mark Carney has been one of just this: ensuring central bank policy can encourage growth.
Thus, investors have been heartened by these predictions of quantitative easing and have been stuffing money in equities and safe havens like the Yen and US treasuries.
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The name’s bond, rallying bond
The bond market, especially US Treasuries, have seen a rocket in demand in the last few weeks.
This was on the back of extremely bearish calls by analysts coming into 2016, and so far there has been a growth in bond prices of 12%, with record-low yields (see below for graph).
However, many are sheepish about this.
The fact is, this is all based on a very low-interest rate environment.
Central banks feel like they need to be doing something to help a stagnant economy.
The Eurozone is barely seeing growth.
Japan obviously hasn’t had any for a while.
Low, zero, or even negative interest rates are nothing more than a band-aid approach to the problem.
Structural reform and innovation will be the long term answer, but that is a whole other huge topic.
Howard Marks is the co-chairman of the Oaktree Capital Group LLC.
He tells us that the current climate is a difficult and low-return one that is completely ignoring significant risk incidents.
Markets shrugging off problems only makes them come back.
The band aid problem.
Any up-cycle will hit a wall eventually, and the accumulated problems will come back with a vengeance.
The conclusion is that if investors want to get in on liquid-light assets, they will also have to be willing to see through the storm that occurs in the bad times.
The name’s yield, negative yield
Risk assets will see heartache and price falls in the tough periods, and so if you need cash in the immediate short term, the best thing is probably not to put it all into illiquid assets.
Groups like Janus Capital Group and Capital LP agree with this.
Governing sources said that with the yields at the current low levels that they are, bonds were simply too risky for the return.
Jeffrey Gundlach of Capital LP spoke of a ‘psychosis’ amongst investors caught in a yield-seeking frenzy.
He quipped, “Call me old school, but I’m not a fan of an investment where your correct prediction is money-losing one.”
The graph below shows the rising amount of negative-yielding debt.
From almost nothing in 2014, we have now seen some fifth of debt being negative-yielding.
Many others agree that it is now highly unlikely that the Federal Reserve will increase rates again.
The Brexit vote has simply thrown too much uncertainty into the global economy, and the predictions for global economic growth look grim indeed.
Earnings fall for Blackrock as investors move to illiquid assets
Blackrock reported a decline in earnings for the second quarter of 2016.
They reported a 3.7% fall in total earnings, as their clients decided to shift money over from stocks to things with lower fees, like fixed income (bonds most notably) and cash investments.
They are significant as they are one of the largest professional and financial services firms in the world, with a total of $4.6 trillion worth of assets under management.
Their performance is indicative of the wider financial market.
They claim their losses are thanks to clients having to navigate a never before experienced financial market atmosphere and investment environment.
One person who we should listen to is Laszlo Birinyi.
He used to be an analyst at Salomon Brothers, one of the oldest operating financial services firms, founded in 1910.
He predicted the post-crisis bottoming out of US stocks in the last quarter of 2008.
He says that because of the investor skepticism evident today, the S&P 500 could rally further, “Were sentiment even more optimistic, we could even see a market top.”
He does not see the end of the bull market coming anytime soon, and his official stance as director of Birinyi associates is that the market will continue to rise.
Heeding his advice recently would have made investors wealthy people.
Final Word
People are asking whether there will be a soft landing for the current environment of low yields, zero or negative interest rates, and slowed growth.
Safe havens are a prime target right now, but how safe they are, remains to be seen, as Tom Keene of Bloomberg explains.
For example, the yen is renowned as a safe haven for investors, but with the recent announcement by the emperor, Akihito, that he will abdicate, a spanner in the works has potentially been thrown.
The yen is a safe haven because Japan owns more foreign assets than has assets owned by foreign investors.
In fact, this surplus is over $3 trillion, making Japan the world’s largest creditor before (in respective order):
- China
- Germany
- Switzerland (thanks to its Swiss Franc mainly)
- Saudi Arabia
And credit ratings are falling fast, with analysts cutting predictions left right and center.
Britain had its slashed from AAA to AA after the Brexit vote, while some 15 others have seen downgrading.
For comparison, the record for a year is 20 in 2011, when the Eurozone crisis was in full flow, and it looked like the world was going to end.
With the market so comfy with low yields, it is understandable why talk of raising interest rates is so scrutinized.
Many investors would lose plenty with a raise in rates, or a reduction in the quantitative easing stimulus programs of the last few years.
When the Fed even so much as discussed putting it on hold, it sparked a huge sell-off of Treasuries.
The low yields are also indicating to some that a recession is looming, as historically it has been associated with a slowing economy.
However, for now, the US economy looks strong in comparison to the rest of the developed world.
The recent payroll report was a heartening one for policymakers, as the best performance for eight months was seen.
So talk of a recession is for the pessimists. Besides, there is always someone trying to predict one next month. Chances are they are hoping to increase sales of their book, in case it actually happens.
