And away we go for another month of reckoning. 2021 is already proving fascinating and volatile. Beware the Bondcano!
What’s the story? Share markets around the world got the wobbles last week because interest rates on the ‘long end’ are rising strongly.
Suddenly all those future earnings and cash flows have to be discounted at a higher rate. Or so the narrative goes.
This places the central banks in an awkward position. Suddenly the market is not so keen to swallow all that debt with a pitiful yield below 1% and inflation.
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That means the central banks will likely have to step in and buy the bonds themselves. See the absurdity of the situation?
Interest rates are rising because of the gargantuan credit expansion of the central banks. Now they have to do more of the same thing to delay the consequence of their original action.
After all, US President Joe Biden has a vaunted $1.9 trillion stimulus package he is trying to get through. Who is going to finance it?
The US federal government is already over US$20 trillion in debt. Either the market must absorb the extra bonds, or the Fed does.
That makes me think of something from the years after 2008.
There was a perception at the time that the US government would mandate pension funds and the like to hold a higher percentage of their clients’ money in bonds — whether they wanted to or not.
If you can win customers in a free market, governments can always come in with the iron fist of force.
The pitch is not even that hard from a regulatory point of view: government bonds are considered a ‘risk-free’ asset.
We’ll see if it gets to that desperate length soon enough. But even Warren Buffett is calling out the problem in bonds with his annual letter for the year.
The Oracle of Omaha says bonds ‘are not the place to be these days…fixed income investors worldwide — whether pension funds, insurance companies or retirees — face a bleak future.’
It’s worth noting Buffett on this. A huge part of his success is his mastery of the insurance business.
He takes in, via his insurance companies, ‘premiums’. This is cold-hard customer money. They get the insurance.
But Buffett has the moolah. And he can do, as he says in the letter, anything he wants with it. He can buy shares, bonds, or whole businesses.
In 1981, he might have bought a 10-year Treasury bond — US government debt — that paid 15.8%.
Today that same bond in terms of maturity earns 1.4%.
We all know that Buffett is no fool. He knows perfectly well that buying bonds at this level is no way to make money. He’s telling us both explicitly and implicitly.
You can see the latter in the way he spent $30 billion of Berkshire’s vast resource to buy back their own shares. Better that than allowing the US government to fleece his investors.
After all, why buy a bond paying a fixed coupon when a torrent of central bank money creation is as certain as anything in the financial world can be?
My friend Dan Denning summarises the current dynamic like this: either the US bond market goes, or the US dollar does. Both are unlikely to hold their current level for long.
The bond market has the Fed at its back. That leads me to think the US dollar will continue to fall in the months ahead.
That will pressure the Aussie dollar back toward parity again.
You might not know that bonds, as an asset class, are bigger than stocks. All that money is going to be looking for a happier home in future years.
This will be something to watch in the US. The typical portfolio in the US was traditionally 60% stocks and 40% bonds. That doesn’t work anymore.
You don’t quite see this from Australia. Aussies typically hold a much higher proportion of their super in the share market. That makes for a volatile ride, but one which the rest of the world is likely to start copying.
No doubt volatility will keep punching angry holes in the market uptrend as we go further into the decade.
But nothing I see makes me forget the basic forecast: stock markets are the place to be for the next five years.
It sure ain’t in the bond market. That the world’s greatest investor tells us so too just adds to the conviction.
Best wishes,
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Callum Newman,
Editor, The Daily Reckoning Australia
P.S: Our publication The Daily Reckoning is a fantastic place to start your investment journey. We talk about the big trends driving the most innovative stocks on the ASX. Learn all about it here.
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