Out of the Box: Through the Looking Glass or Down the Rabbit Hole

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There are many theories about how we got here. Some focus on investors, while others focus on the central banks. I am not a buyer of either theory. In my opinion, we have reached a whopping $17 trillion in negatively yielding bonds solely because the nations of the European Union, Switzerland and Japan have instructed their central banks to lower yields. This is because their budgets, and social programs, could no longer be afforded without raising taxes, or selling off assets, and so their central banks have done, as they were told.

There is absolutely no other reason for this phenomenon. There is no other cause for it, regardless of how much the European Union subjugates this position. They, of course, the various governments, do not want to take responsibility for it and so they try to wash away all mention of it. I get this joke, most people, and institutions, accept the official view that it is the ECB making the decisions. I say, “Hogwash!”

All of this leads to one other conclusion. The nations of the EU are in real trouble financially, or they wouldn’t be resorting to negatively yielding debt. How good it is, for these governments, to borrow money and get paid for it, and break thousands of years of tradition, where the borrower pays the lender for the money. You know you are in “Wonderland” when you can borrow money, and have the lender pay for the privilege of handing it to you.

Remember, the U.S. central bank, the Fed, has some “Independence,” as mandated by the Federal Reserve Act of 1913. Their mandates can, and have, been changed by Congress before. Congress could also disband the Fed, and this has also happened before. Regardless of their “Independence,” the Fed is part of the government of the United States and is directed by Congress to operate as the American central bank, and not the world’s central bank.

The situation with the Fed, I point out, is “totally” different than the other major central banks of the world. The ECB, the SNB and the Bank of Japan are one hundred percent directed by the governments they represent and do nothing, other than their bidding. When the ECB speaks it is nothing more than the echoes of Berlin and Brussels. Nothing else.

To make matters worse, for investors, thirty percent of all investment-grade securities now bear Sub-Zero yields, meaning that investors who acquire the debt, and hold it to maturity, are guaranteed to take a loss. Yet, people are still buying this stuff. One gambit may be that yields are going lower still and so a profit may be made but, to me, that is just lunacy.

“We’re all mad here.”
-Wonderland

CNN reports that, “Siemens just borrowed $1.6 billion without offering a penny in interest. it’s another sign that investors are betting that rates are going to fall even further as storm clouds gather over the global economy. The German industrial conglomerate this week borrowed €3.5 billion ($3.8 billion) from investors in the lowest-yielding bond issue ever recorded by a company, according to a source familiar with the transaction. Siemens (SIEGY) borrowed €1.5 billion euros ($1.6 billion) over two and five years. Those bonds offered a zero coupon (interest rate) and were priced with negative yields…”

I have all seen some calls, in the Press, that we are in some sort of “Bond Bubble.” I don’t accept this viewpoint either. What is happening here, as I have stated before, is that governments are causing this historical deviation by creating “Pixie Dust Money” and then using it to buy bonds, and other securities, so that they are off the hook for their budgets. Foreign institutions, besides the central banks, then buy these bonds as an “accommodation” to their governments, meaning that they can still manage pension money et al, as they are good corporate citizens.

All of this also means, in my opinion, that American yields are headed even lower, regardless of the ministrations of the Fed. The Treasury Department, in their latest data, show that foreigners bought $64 billion of American securities in June. The equity portion was $26.6 billion while the bond portion totaled $37.4 billion. This brings the total American securities purchases by foreigners, to $136 billion in the first half of the year.

In the last few months the sovereign and corporate yields, in the European Union, have headed even lower and so America is about the last man standing, of any major country, with positive yields. Consequently, I see even more money flowing into our markets. America is also about the last stable country to invest in, with Germany teetering on recession, Brexit underway, and Italy in political turmoil.

Then the ECB meets on September 12 and I expect an expanded program there. Currently the Fed has assets of $3.7 trillion representing 18% of our GDP. The ECB has assets of $5.3 trillion representing about 40% of their GDP and I expect this number to rise, after their meeting, and Quantitative Easing to be re-started.

Make note, this is one of the best times to be a borrower, on record, and one of the worst times to be an investor. Sure, equities have risen some recently ,and some “appreciation plays” have done well, but it you need income, with the exception of the closed-end fund space, it is very difficult to find any. Closed-end funds, in my view, are about the only place left with double digit yields, and monthly payments, and a diversity of strategies, but you have to know what you are doing, to pick the correct funds, in this complicated world.

Negative yields, in my opinion, are just poisonous.

“If you drink much from a bottle marked ‘poison’ it is certain to disagree with you sooner or later.”
-Wonderland

Mark J. Grant
Chief Global Strategist, Fixed Income
Managing Director
B. Riley FBR Inc.
Mgrant69@Bloomberg.net
U.S. 954-468-2366

Information herein is for general use; is not unbiased/impartial; is current at publication date, subject to change; may be from third parties; and may not be accurate or complete. Opinions are the Author’s, not B. Riley FBR, Inc., or their respective affiliates or subsidiaries. This is not a research report or solicitation or recommendation to buy/sell the subject securities. Investment factors are not fully addressed herein. B. Riley FBR Inc. and their affiliates may have a proprietary position in the subject securities. Redistribution/reproduction of this material is prohibited. See additional disclosures at: http://brileyfbr.com/legal/legal_disclosures

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