Immensely Concentrated Positions in “Fantastically” Overpriced Markets with “Unlimited Tolerance for Risk”

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The miraculous multi-year performance of the stock markets and the even more miraculous performance of the bond markets are the proudest achievements of the major central banks around the globe, led by the biggest of them all, the Fed. By now, $4 trillion in developed-world government bonds have soared to such heights that they sport “negative” yields where investors pay to hold this paper, and these investors are jostling for position to do just that.

The extent to which this has happened – are that many investors that stupid or panicked? – has befuddled many rational minds.

“We think it is actually quite nutty to continue holding long-term developed-world government bonds at current levels,” that’s how the $25-billion hedge fund Elliott Associates explained the phenomenon in a client letter, which Bloomberg and Reuters had obtained. It had more choice nuggets:

Today’s trading levels of stocks and bonds reflect ‘thumb on the scale’ valuations driven by persistent and massive government asset purchases and zero percent (or lower!) short-term policy rates, as well as an essentially unlimited tolerance for risk on the part of large segments of the international investing community.

These global stock prices “cannot possibly reflect the best analysis of millions of investors regarding the prospects of private-sector corporate profits.”

Elliott Associates was founded by Paul Singer, who is infamous for trying to squeeze big gains out of “distressed” bonds issued by deadbeat governments. His fund is among the “holdouts” – the evocatively named “vultures” – that own the 7% of Argentina’s long-defaulted dollar-bonds whose holders  refused to participate in the debt restructuring that left the other 93% with a high-and-tight haircut. It has been over a decade that these holdouts have been trying to squeeze some juice out of Argentina, and the jury is still out if they will ever succeed [for the latest episode of that soap opera, read…  In 2015, it Boils Down to this: Argentina Could But Will Not Pay Because President Christina Doesn’t Want to].

For years, Singer has been a thorn in the side of governments for failing to deal with structural problems. Not that they paid any attention. And he has been lambasting the Fed and other central banks for QE, which doesn’t fix those structural problems but instead inflates asset prices into absurdity. Last year, as the US economy once again failed to obtain escape velocity, he pointed out that the economic data understate inflation and overstate growth. He wasn’t the only one to have figured that out.

Elliot’s current letter lambasted the ECB for its recently announced and soon to kick in €60 billion-a-month QE program. It wouldn’t solve the Eurozone’s problems and wouldn’t improve its economy. Instead, if this round of QE leads to a general loss of confidence, there might be “large negative repercussions.”

While these market manipulations by central banks and governments have driven bond markets to absurd levels, Singer warned that his firm had to make money: “We believe strongly that today’s prices and yields are extreme and unsustainable, but our wish not to be run over trumps our view that long-term, bonds are overvalued.”

“But our wish not to be run over…”

Singer’s hedge fund couldn’t be clearer: These prices, including for developed-market government bonds, were “unsustainable,” and thus would come down. Meanwhile, his firm needed to make money, and the money was on betting with central banks, not against them. So the firm invests in these treacherous markets. And everyone else does too. Hence, these immensely concentrated positions in “fantastically” overpriced markets.

And they all know: As a result of global monetary policies, the most conservative investment – government debt – has become a potentially toxic investment because it is priced at absurd levels, but no one could acknowledge it, and everyone had to play along because they wanted to make money, and the money has been in betting with the central banks. Anyone stepping out of line could get clobbered.

Central banks have cowed investors. But that’s where the money is to be made … until suddenly it isn’t.

The Swiss National Bank, when it ended the cap of the Swiss franc without warning, caused the franc to soar in seconds. It mauled traders and hedge funds that were short the franc – one of those hitherto risk-free bets, based on the now false promise by the SNB to maintain the cap.

The next trading crisis could be triggered by a similar surprise decision by a central bank to renege on its promises, Elliot’s letter explained. It would diminish “the perceived credibility of unequivocal government promises….” But that’s the force that has inflated asset prices to these absurd levels. Once that “perceived credibility” is whittled down, financial markets  will lose their footing. That’s what the SNB decision and its consequences have demonstrated. And everyone tried to get out of the same position at the same time. But until then, everyone will be lined up on the same side, partying along in order to not get “run over” – only to get run over when the scenario suddenly changes.

Ratings agency Fitch and the Bank of Canada have warned about it last year. And now it has come to pass. Read… Canada Mauled by Oil Bust, Job Losses Pile Up – Housing Bubble, Banks at Risk

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  9 comments for “Immensely Concentrated Positions in “Fantastically” Overpriced Markets with “Unlimited Tolerance for Risk”

  1. Dan Romig
    Feb 3, 2015 at 6:42 am

    By most measures, the U. S. stock markets are overvalued. But the question is, where else do you invest your capital?

    “… governments… failing to deal with structural problems.” This sure applies here in the U.S.!

    As long as our debt to GDP ratio continues to grow (the CBO has stated it will remain higher than GDP for at least another decade), and as long as the Fed can keep rates very low to buy Treasury Notes inexpensively, this cycle of more debt will just keep on keepin’ on. Citizens, batten down the hatches if and when the interest rates of short term T Notes climb up to a few percent points. Remember, eight years ago the 1 year T Note was 5%!

    Can anyone in the White House, Congress or the Fed tell us what the end game is here?

  2. Michael Gorback
    Feb 3, 2015 at 6:59 am

    “As long as the music is playing, you’ve got to get up and dance”. Chuck Prince, 2007

    Good times, eh?

  3. Vespa P200E
    Feb 3, 2015 at 10:14 am

    Global CBs’ QEs and hide the weenies (sovereign debts) can last so long with each round of QE’s impact muted and side effect of pumping the equity and RE markets…

    As for the eye popping sovereign debts – what a shame that our government borrow to hilt to live for today not realizing that our children will inherit the debts with ballooning interest payments as we all know the debt timebombs are kicked down the road and there is no way in hell that national debts can ever be paid off. Add to this Obozo the ex-community organizer added 8 trillions of debt. BTW – national debt was 10.6 trillion when Hussein (his real middle name) took over mere 6 yrs ago.

    AUDIT THE FED!

    • Mick
      Feb 3, 2015 at 5:27 pm

      When the FED was audited around 2008,it was discovered they printed 17tn already. Don’t believe for one second they’ve only printed 4 trillion to achieve this 6 year bubble.
      The FED will be audited and we will find out the real number is closer to 100 trillion.

  4. retired
    Feb 3, 2015 at 10:48 am

    Anyone out there want to buy large quantities of tulips?

  5. Julian the Apostate
    Feb 3, 2015 at 1:32 pm

    Do you have one of the pretty white ones with the red vertical stripes? Trade you my house for it…

  6. Vespa P200E
    Feb 3, 2015 at 2:09 pm

    Hey ever heard of South Sea Bubble akin to the tulip craze?

    From the net:

    South Sea Bubble, popular name in England for the speculation in the South Sea Company, which failed disastrously in 1720.

    . Holders of £9 million worth of government bonds were allowed to exchange their bonds for stock (with 6% interest) in the new company, which was given a monopoly of British trade with the islands of the South Seas and South America.
    The monopoly was based on the expectation of securing extensive trading concessions from Spain in the peace treaty. These concessions barely materialized, however, so that the company had a very shaky commercial basis.

    Nonetheless, it was active financially, and in 1720 it proposed that it should assume responsibility for the entire national debt, again offering its own stock in exchange for government bonds, a transaction on which it expected to make a considerable profit. The government accepted this proposal, and the result was an incredible wave of speculation, which drove the price of the company’s stock from £128 1-2 in Jan., 1720, to £1,000 in August. Many dishonest and imprudent speculative ventures sprang up in imitation.

    In Sept., 1720, the bubble burst. Banks failed when they could not collect loans on inflated stock, prices of stock fell, thousands were ruined (including many members of the government), and fraud in the South Sea Company was exposed. Robert Walpole became first lord of the treasury and chancellor of the exchequer and started a series of measures to restore the credit of the company and to reorganize it. The bursting of the bubble, which coincided with the similar collapse of the Mississippi Scheme in France, ended the prevalent belief that prosperity could be achieved through unlimited expansion of credit. Legislation was enacted that forbade unincorporated joint stock enterprise.

  7. Howard Beale IV
    Feb 3, 2015 at 10:30 pm

    “Meanwhile, his firm needed to make money, and the money was on betting with central banks, not against them. ”

    No one is putting a gun against his head here. Normally hedgies like to bet against something, but now he can’t-sounds like he’s whining to me.

  8. Julian the Apostate
    Feb 4, 2015 at 9:16 pm

    Bubble bubble toil and trouble. The Witching hour is upon us. We have heard of those bubbles of course, Vespa. But no one reads history anymore. Mores the pity.

Comments are closed.