Permanent moral mental market incapacity

SODERMALM, STOCKHOLM – As the week draws to a close, it’s time for some light relief. We’ve written often about the strange happenings taking place in the bond market in recent years – like countries being paid to borrow money, and companies borrowing for a hundred years – but I think this takes the cake.

From Grant’s, emphasis mine:

Peru launched a $4 billion, three-part sovereign debt offering yesterday, including $1 billion worth of 101-year bonds at 3.23%, José Olivares, director-general of the Public Treasury of Peru’s Economy ministry, told Reuters. That marks the lowest yield on an emerging market century bond yet…

… the A3/triple-B-plus-rated South American nation has its investment merits. “Peru has a strong external position and a low level of indebtedness,” Shamaila Khan, director of emerging market debt at AllianceBernstein, told Bloomberg. “We expect the country to be a solid investment grade credit, despite the political volatility.”..

Internal self-assurance remains in abundant supply. “Independent of the political events, there’s a confidence that investors have in the financial institutions of our country,” declared José Olivares today in an interview with Bloomberg. “When they talk about Peru bonds, they say it’s a risk-free asset.”

I love how it’s not just a 100-year loan which the Peruvian Treasury succeeded in getting from the market, but a 101-year loan.

Why the extra year? What’s scheduled to take place in a century that they want to avoid?

Is there an election scheduled in 2120 that would complicate the repayment of the loan? Maybe the government is due to come into some money in 2121?

The Peruvian Treasury was likely just rinsing the bond market for as much cash as it can get. And why not? If the bond market is both rich and dumb enough to be writing these cheques, why not take ‘em for a ride? More power to ‘em. Hell, why not really push the boat out and break records with a bi-century bond?

What makes this event quite so astounding to me though is the political environment in which these loans have been made.

Peru is on its third president in a month. The first was impeached on 9 November on account of “permanent moral incapacity”. The second lasted less than a week after a police clampdown on those protesting his premiership led to broad civic unrest and rioting, and the third – one Francisco Sagasti – has just been sworn in. Don’t get too comfortable with him though: there’s a general election in April next year, and he might not even make it that far.

The issuance of these bonds occurs in the midst of an utterly chaotic period of violent protests brought on by government graft and ineptitude. Roughly half of the Peruvian congress are under investigation for corruption (but are protected by parliamentary immunity).

Out of the last nine presidents Peru has had since 1990, one is in jail, two are under house arrest, two are under active investigation by the police, one is awaiting trial and banned from leaving the country, and another killed himself when the police showed up to arrest him. Their crimes range from corruption, bribery and money laundering, to the killing of civilians.

Talk about credit quality – I want to write ‘em a cheque right now! Get my broker on the line – do they have any more of those century bonds in stock? Would the Peruvian Treasury be gracious enough to issue some more? 3% interest is 3% interest – and the Santander 1-2-3 account just doesn’t pay that any more…

Even if you’re “investing for the long term” and expect the century bonds to outlast this political volatility, the last 100 years of Peruvian history don’t inspire a great deal of confidence. As Reuters columnist Robert Cyran observed wryly, the yield on these century bonds is lower than the number of Peruvian coups that have taken place in the past 100 years.

“Past performance is not indicative of future results”, as we so often say in the financial industry. For the sake of the people of Peru, I certainly hope that’s true. But were I to buy these bonds, I would fear for my own arrest on the grounds of “permanent mental incapacity”…

Century bonds are nothing new in South America. Argentina borrowed $2.75 billion with a 100-year repayment date just in 2017. Three years on and Argentina has already begun “restructuring” the debt (read: defaulting) – those dumb enough to lend such a profligate government money are now guaranteed a loss of almost half their principal. Good luck making it to 2117, fellas.

For Peru to borrow for 100 years at a record low rate is an indicator of just how extreme the global investment environment has become. Specifically, it’s a testament to just how much risk those seeking the stability of a fixed income are willing to take in a world of no interest rates. One might call it “permanent market incapacity”: there’s no risk too great now, no loan too extreme, provided it pays a yield in the meantime.

Raymond DeVoe Jr, the great market commentator born in New York City a month before the 1929 crash, once said that “more money has been lost reaching for yield than at the point of a gun”.

The big man said that in the mid-90s, and passed away in 2014. If only he could see this. It has never been truer that “Man’s reach exceeds his grasp” – especially when it comes to yield.

All the best,

Boaz Shoshan
Editor, Capital & Conflict

PS While the mayhem above on the surface may be off-putting, I expect Peru will attract the eyes and wallets of many investors in the future for a certain advantage it has over every other nation in the world.

Peru has a silver lining – literally. The world’s largest silver reserves reside in its soil. And if the silver price does what I expect it to in the near future, Peru stands to benefit and will hopefully achieve a greater level of stability and prosperity than it does now. But that’s a topic for a future letter…

Category: Economics

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