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