SIMON LAMBERT: Bond king Bill Gross is right, the investing world's gone mad - beware the day it wises up
King of Bonds: Bill Gross sounded another warning on the bond market this week and the disaster of trying to cure a debt crisis with more debt
The financial world has gone mad.
We look back in wonder at the dot com bubble, but would a time-travelling observer from that era find today saner?
They would encounter central bank money printing, an extreme reliance on interest rates staying on the floor, and recently and perhaps craziest of all, negative interest rates.
Negative yields mean that investors are buying bonds guaranteed to lose them money if held to maturity.
Here, investors pay for the privilege of lending money to governments and companies.
Some of those investors are institutional, such as insurance companies and pension funds, and are duty bound to buy bonds.
But that’s not true for all. Others have been buying out of choice.
This seems to be the epitome of greater fool theory.
Bonds are being bought not for their essential function – paying investors interest – but in the belief that someone will buy them for more money down the line, that aforementioned greater fool.
The motivation for buying bonds at any price can’t be because fearful investors are desperate for their supposed safety, because stock markets have simultaneously been hitting record highs.
There has been no shortage of people questioning this mad world. But any attempt to sit it out has proved costly compared to going with the trend.
Some big names have been caught out that way. One of those, the famous investor dubbed the King of Bonds, Bill Gross, railed again this week at, ‘the less than commonsensical notion that a global debt crisis can be cured with more and more debt.’
His letter to investors honed in on, ‘a sense of an ending, not another Lehman crash, but a crush of perpetual bull market enthusiasm’.
Interestingly, his comments come after the negative yield rush has fizzled out. Bond yields have jumped in recent weeks and prices, which move in the opposite direction, have slipped.
BONDS ON THE SLIDE
Over the past three weeks, bond prices have fallen and yields risen.
Yields on five-year German Bunds have climbed out of negative territory, from -0.15 per cent to 0.07 per cent.
Ten-year German Bunds have leapt from 0.07 per cent to 0.53 per cent.
US ten-year yields are up from 1.87 per cent to 2.22 per cent, UK ten-year Gilt yields are up from 1.5 per cent to 1.99 per cent.
This could once more prove to be a blip, or a more sizeable taper tantrum-style shakeout that quickly fades away, as happened when markets threw a strop in 2013 at the mooted trimming of US quantitative easing.
Alternatively, it could prove to be the beginning of the end of ‘the great Bull Run that began in 1981’, as Gross suggests.
So what can an investor do?
You could get out of the game and run for the near zero-return safety of cash. But what if you find that unpalatable?
One answer is not to buy or hold expensive stuff. When the inevitable correction comes, everything will fall - but history tells us the most overvalued assets are likely to be hit the hardest.
That’s not just hyped up internet stocks this time, but some of the supposedly safest investments around, including government bonds.
That alone should be enough to at least make you consider what people like Bill Gross are saying.
Bill Gross: A sense of ending - some highlights
Here are some excerpts from Bill Gross’ investment outlook for Janus Capital:
A ‘sense of an ending’ has been frequently mentioned in recent months when applied to asset markets and the great Bull Run that began in 1981.
‘Then, long term Treasury rates were at 14.50% and the Dow at 900. A ‘20 banger’ followed for stocks as Peter Lynch once described such moves, as well as a similar return for 30 year Treasuries after the extraordinary annual yields are factored into the equation: financial wealth was created as never before….
‘…Policymakers and asset market bulls, on the other hand speak to the possibility of normalization – a return to 2% growth and 2% inflation in developed countries which may not initially be bond market friendly, but certainly fortuitous for jobs, profits, and stock markets worldwide.
‘Their ‘New Normal’ as I reaffirmed most recently at a Grant’s Interest Rate Observer quarterly conference in NYC, depends on the less than commonsensical notion that a global debt crisis can be cured with more and more debt.
‘At that conference I equated such a notion with a similar real life example of pouring lighter fluid onto a barbeque of warm but not red hot charcoal briquettes in order to cook the spareribs a little bit faster. Disaster in the form of burnt ribs was my historical experience. It will likely be the same for monetary policy, with its QE’s and now negative interest rates that bubble all asset markets.
But for the global economy, which continues to lever as opposed to delever, the path to normalcy seems blocked….
‘…Even the three strongest developed economies – the U.S., Germany, and the U.K. – have experienced real growth of 2% or less since Lehman. If trillions of dollars of monetary lighter fluid have not succeeded there (and in Japan) these past 5 years, why should we expect Draghi, his ECB, and the Eurozone to fare much differently?
‘Because of this stunted growth, zero based interest rates, and our difficulty in escaping an ongoing debt crisis, the “sense of an ending” could not be much clearer for asset markets. Where can a negative yielding Euroland bond market go once it reaches (–25) basis points? Minus 50? Perhaps, but then at some point, common sense must acknowledge that savers will no longer be willing to exchange cash Euros for bonds and investment will wither….
‘…At the Grant’s Conference, and in prior Investment Outlooks, I addressed the timing of this ‘ending’ with the following description: ‘When does our credit based financial system sputter / break down?
‘When investable assets pose too much risk for too little return. Not immediately, but at the margin, credit and stocks begin to be exchanged for figurative and sometimes literal money in a mattress.’
‘We are approaching that point now as bond yields, credit spreads and stock prices have brought financial wealth forward to the point of exhaustion. A rational investor must indeed have a sense of an ending, not another Lehman crash, but a crush of perpetual bull market enthusiasm….
‘…I wish to still be active in say 2020 to see how this ends. As it is, in 2015, I merely have a sense of an ending, a secular bull market ending with a whimper, not a bang. But if so, like death, only the timing is in doubt. Because of this sense, however, I have unrest, increasingly a great unrest. You should as well.’
Should you be worried? Watch our latest Investing Show for a discussion of the risks for investors