Art Samberg, Mario Gabelli, Leon Cooperman and Russell Carson share their thoughts on today’s market valuations and the economy at the Columbia Business School’s 2017 Reunion Weekend.
A few years ago Vanguard performed a study to see how the Barclays Aggregate Bond Index would be affected by an overnight 3% rise in interest rates (something that has never actually occurred). They calculated what would happen if rates suddenly rose from 2.1% to 5.1% and showed the impact going out 5 years:
You can see the immediate loss would be around 13% (they also noted that the worst 12 month loss ever in bonds was -13.9% in 1974). But because the yield on bonds would now be much higher, the expected return going forward would now be around 5.1% annually, meaning the breakeven would be just over 3 years. So not exactly a crash of epic proportions.
European Central Bank policy is having unforeseen consequences and this one is a real head scratcher, getting paid by the bank to borrow money. How long do you think this can last?
But it isn’t all bad. Some Danes with floating-rate mortgages are discovering that their banks are paying them every month to borrow, instead of charging interest on their home loans.
Investors have been looking for income from alternatives to low yielding bonds since the Federal Reserve lowered the interest rates to zero after the 2008 financial crisis. This search for income in a low interest rate environment has led to a huge inflow of investment into master limited partnerships and high yield bonds over the last few years. According to the Wall Street Journal, from 2010 to 2014 a net $44 billion flowed into MLP mutual funds and exchange-traded funds. Lured by yields of 6% plus at a time where the 10 year treasury bond yields 2 percent, investors have been forced into assets that carry far more risk.
Why would an investor pay a central bank to hold their money? There are only two reasons I can think of. One, you are speculating that another investor will come along and pay a higher price to buy the bonds from you (current European Union Central Bank scenario) or two, you are seeking safety in a very unstable environment where your only concern is the return of your principal.
Today’s negative yields are the manifestation of central bank policy pushed to an extreme.
Germany sold two-year government debt at a record low yield of minus 0.38 per cent on Wednesday, in a move reflecting expectations of further monetary easing for the eurozone next month. The policy-sensitive two-year bond offers a coupon of zero,
Barry Ritholtz’s new Washington Post column nails one of my favorite lessons from Economics, “There’s No Such Thing as a Free Lunch” (The Washington Post)