Out of the Box: The Markets Are In Franz Kafka Territory
“They say ignorance is bliss….they’re wrong ”
If someone had told me, during my long career on Wall Street, that one day there would be negative yielding bonds I would have thought that person “Nuts!” It made no empirical sense then, and it makes no empirical sense now. Yet, we have them, about $13.4 trillion of them, and they are likely to grow in size, as soon as Ms. Lagarde takes over the helm at the European Central Bank. There is a reason that these bonds exist, and one reason only, and it is because the nations of the European Union, and Switzerland, and Japan have mandated that their central banks take rates to these levels so that their countries can survive. Yes, I said, “Survive.”
The plain truth is that all of these nations cannot support their budgets, their social programs, and support any kind of growth without them, so Germany, France, the Netherlands et al have all instructed the ECB to buy sovereign and corporate debt with money created from nothing except the keystroke of some central bank’s trader, on the Continent. The amount of negatively yielding Investment Grade bonds has risen to $600 billion. Now, in an even more surprising twist, junk, or High Yield bonds, are also showing negative yields. Fourteen companies in Europe, rated BB or less, are being paid to borrow investor’s money. In total, 2.00% of European High Yield bonds have yields of less than Zero.
“Beyond a certain point there is no return. This point has to be reached.”
JPMorgan just issued a white paper stating that, “There’s a serious probability that in the next three years U.S. Treasury yields are at zero, if not negative, and the whole market is sitting at zero and negative yields.” JPM goes on to state, “Don’t assume the U.S. is so different than the rest of the world. Europe and Japan are giving a warning that the same things that happened there could also be happening to the U.S.”
BlackRock’s Chief Executive, Larry Fink, said on Friday that “The monetization of financial assets in Europe, especially now with over 50% of its debt yielding below zero, actually harms the psychology of savers. He also said Europe has been “so reliant on monetary policy and so little fiscal policy. That will be one of the long-term mistakes of Europe. Unfortunately, the only name in town is the ECB. They’re trying to do whatever they can do to do it. I think now with all the negative rates, and with 82% of savings in a bank account, I just don’t see how that transmission works as well as lowering rates in the United States.”
He also echoed what I have been warning about, for quite some time now, that the European Central Bank will need to purchase equities to stimulate Europe’s economy. This would be following Switzerland and Japan down the rabbit hole. If this takes place then the ECB will be dominating and controlling all of the European markets as their governments flail in the wind of broken dreams. I would state that the governments in Europe have failed, and ceded power to their central bank, in a last-ditch effort to keep their economies alive. From an investor’s viewpoint, you can’t fade them, as the people that make the money will always win as they have an ability, “monetary creation,” that you do not.
Now, as a percent of local currency nominal GDP, the Fed’s assets are at 18.9% of America’s GDP, while the ECB’s are at 39.8% of the EU’s GDP and the Bank of Japan’s are at 100.80% of Japan’s GDP, according to Yardeni Research. There is more here than meets the eye, however. This then means that the “Real” debt to Gross Domestic Product (GDP) number is much higher than stated because the assets and liabilities of the central banks also reflect back on the countries that own them.
So, in the case of the United States, our stipulated debt to GDP number is 106.10% which becomes 126.15% if the assets/liabilities of the Fed are included. For the EU, where the stipulated debt to GDP figure is 85.10%, it means that the “Real” number is 119.0% if the ECB’s assets/liabilities are included. For some specific countries the numbers get scary, such as Italy, with a debt to GDP figure of 132% which would escalate Italy’s “Real” number to 184.50%, if the ECB’s data were included.
“God gives the nuts, but he does not crack them.”
All of this also means that the Fed, and the government of the United States, is getting backed into a corner. We can hardly compete, economically, by raising taxes, when the rest of the world no longer raises taxes but has their central banks create new money, to pay for their desires. America, in my opinion, is now up against it, with our backs against the wall, as the boys and girls in Europe and Japan have changed the rules of the game. Borrowers are getting a windfall, and investors are feeling the heat, as the antics of the central bankers take their toll.
In America, the lagging nation, we still have time for equities up, Real Estate up, as bond yields head to Zero, or less and probably in short order. We are in an investing cycle never before seen, ever, because the central banks are going to grow negatively yielding debt in magnitudes, in my estimation, which is something that has never occurred before. You may ask if there is an end-game, which might occur, but is years, if not decades away, when the fallout will come in the currency markets. There, eventually, will also be a profound negative reaction in both equities and Real Estate as the costs of borrowing money no longer affect asset prices. However, especially in the United States, we are nowhere close to that paradigm presently.
I reiterate, “The Markets Are In Franz Kafka Territory.”
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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