A weekend anecdote from Eric Peters, CIO Of One River Asset Management
“Everything is 10-times bigger now,” said the CIO. A 2% move in stocks feels like 20%. And a 10bp move in bond yields feels like 100bps. “It’s the kind of thing that happened to Alice in Wonderland.” When you combine negative rates with leveraged carry strategies, anything becomes possible. You can justify almost any price for an asset provided policy makers can suppress volatility. “But elevated asset prices come at the cost of systemic fragility. Because to suppress volatility requires feeding the beast with ever more stimulus.”
“30-year Japanese gov’t bonds yields jumped from 0.05% to 0.50% in 4 weeks,” continued the same CIO. Their price fell 15%. “The person who locked-up their money for 30yrs in exchange for 1.5% in cumulative interest payments, lost 15% of principal. That’s 300yrs of interest, lost in a month.” And the Bank of Japan just signaled that they want a steeper yield curve. Which means more losses to come. “These instruments are nuclear bombs. They’re toxic waste. They’re owned but un-ownable. Not even Alice encountered such nonsense.”
* * *
Kaboom! The earth shook. A manmade tremor. The chubby North Korean kid had popped off another plaything. The dark side of mankind’s technological coin. You see if Apple can waterproof an iPhone 7 supercomputer, any paranoid dictator can eventually miniaturize a nuclear weapon; if we allow him. And we have. Naturally, every coin has two sides, and mankind’s eternal tale is shaped by how we react to our tails. We responded to a bad 2008 coin flip with massive monetary stimulus, extending the limits of what was once thought technically possible. But after eight straight years of landing on heads, we’re again growing nervous about that inevitable, overdue tail. G20 leaders convening in China announced, “We will pursue innovative growth concepts and policies by forging synergy among fiscal, monetary and structural policies, enhancing coherence between economic, labor, employment and social policies as well as combining demand management with supply side reforms, short-term with mid- to long-term policies, economic growth with social development and environmental protection.”
Having studied our disastrous reaction to the 1929 tail, and frightened by the rising anger that led to Brexit, Trump, Sanders and Le Pen, policy makers appear intent on boosting economic growth through fiscal expansion, structural reform. They’d better deliver for the sake of society. But never in history have both bonds and stocks been this expensive simultaneously. Which is perfectly fine, so long as rates stay low and investors expect to flip heads yet again. But can bond prices sustain these levels once policy makers commit to aggressive borrowing/spending? No one knows. Is that the dark side to today’s innovative policy coin? Unsure. And with Draghi disappointing markets by not expanding his balance-sheet expansion, and the BOJ indicating it wants Japan’s yield curve steeper, are central bankers finally finished?
Investors rightly wonder, uncomfortably, hoping for heads, terrified by tails.
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