Yesterdayâs post was about the potential savings tragedy unfolding in the bond market. I say âsavings tragedyâ because high-quality government bonds are still thought to be ârisk free.â But to call them that probably violates some âtruth in advertisingâ standard somewhere.
I asked Tim Price about this issue on the recent quarterly conference call for subscribers to The Price Report. Is there really such a thing as a high-quality, risk-free government bond? Tim followed up that issue in a recent email reply. He wrote:
With 30% of the entire sovereign bond market now trading at a negative yield, bonds no longer make sense as an investible asset class. So bonds per se should probably be avoided â investors buying them today and holding them to maturity are locking in a guaranteed loss. That clearly doesnât make any sense at all, but reflects just how much damage central banks and their financial repression have inflicted on the financial system.
Given the knock-on impacts of the chaos in bond markets, it makes sense to avoid most types of financial stocks, especially banks and businesses associated with pension funds â a pension fund crisis could easily be an outcome of the insanity now being perpetrated in the bond markets.
I would also avoid having significant exposure to cash. With the BRRD banking recovery and resolution directive now live across Europe, the threat of bank bail-ins (per Cyprus) rises by the day. If you do hold cash, make sure itâs in the most reputable banks, not European ones.
It probably makes sense to own inexpensive, yielding assets, and especially real assets rather than paper ones. Loss of market confidence is not a linear process â the bough remains solid until it finally breaks, but forecasting precisely when it breaks is impossible. Investors should be prepared.
Lots to mull over there. But I want to focus on the bright side of Timâs remarks: Japanese equities. It relates directly to the negative yield on 10-year Japanese government bonds that I mentioned yesterday. Itâs not just an amusement park attraction. Itâs a âweight of moneyâ issue.
Japanâs government debt-to-GDP ratio is the highest in the world, well over 200%. That high ratio is possible because 90% of the debt is held by the Japanese themselves. The Bank of Japan alone owns 30% of that debt. One banking analyst calls this âfiscal funding,â which is a polite description for debt monetisation, which is a euphemism for a government that can no longer pay for itself.
But back to bonds. Pension funds and insurance companies like long-term government bonds because theyâre low-risk and have a predictable return. The negative yield on 10-year government bonds begins to change all that. When the borrower (the government) actually earns money by borrowing, the lenders have a choice to make.
Tim reckons that choice will become simple for fund managers and holders of large pools of cash in Japan. Theyâll rotate out of government bonds and into Japanese stocks, where they are already âunderweightâ according to traditional asset allocation models. There will be a torrent of cash that moves out of the Japanese bond market and into the stock market.
Itâs a compelling argument, donât you think? Tim went into a lot more detail on the call. But I wanted to share that observation with you here. It shows, I think, what Tim, Charlie, Alex and all of us are trying to do for you: turn big picture events into investment ideas you can use to save or make money.
Category: Market updates