The first version of this blog was posted 3 hours ago but did not take. Here we go again.
Today Bloomberg wrote:
“The percentage of corporate bonds considered in distress is at the highest in six months, a sign that debt investors expect the economy to slow and defaults to rise.
“The number of speculative-grade companies worldwide with yields at least 10 percentage points more than government bonds climbed to 399 this month, or 16.7% of the total, the highest share since Dec., according to Bank of America Merrill Lynch index data. The ratio compares with 9.2% on April 30, which was the lowest since Nov. 2007.”
This move into Treasuries and foreign equivalents marks market panic. The first thing it tells us is that the government should use the cheap funding it can get to relaunch the economy because the private sector is being ovrcharged for money. If lenders are frightened of inflation, they wouldn’t lend to Uncle any more than to Bank of America or Goldman Sachs, which have to pay a spread of 257-8 basis points over Treasury bonds for 2020 maturities.
The other lesson is for investors. After hesitation for fear of margin calls, I’m taking full advantage of the leverage provided by the Interactive Brokerage account to borrow at 1.28% for my portfolio of non-US corporate and convertible debt, and foreign real estate and emerging market debt, yielding around 8%. So with care, I’ve added to positions and now have 35% more invested than I started out with. I am being opportunistic using investment vehicles like funds, ETFs, and high yielding foreign common or preferred stocks. While I am still in a defensive mode, I think I am being less risk-averse as the bond market correction proceeds.
Since govt bond yields are so low, it is hard to argue that it is “crowding out” the private sector. What we are seeing is a collapse in confidence that corporations will continue to earn more money and repay their debts. These are Wall St.’s upscale finance finest. Morgan Stanley pays even more;2.96% extra, but only to 2015; JPMorgan-Chase pays only 1.51 over 2020 T-bonds. All bond data from today’s Barron’s.)
Moreover those corporations which do have cash to hand are hoarding it. The US Association for Financial Professionals did a survey in May which shows that corporate execurives plan to expand their cash holdigns over the next 6 months rather than spending it, according to today’s Financial Times.
Another anomoly is that foreign non-finance sector borrowers, with the exception of houndogs like BP, are not having to pay anywhere as much as the giant sucking squid, again according to Barron’s.
Borrow more to gain more yield.As determined by the Ottawa Summit, U.S. fiscal and monetary tightening will come, in 2013. That is something like St. Augustine writing in his Confesisons: “Make me chaste, O Lord, but not yet.”
The Fed has won world permission to keep rates down for the foreseeable future. That is what they want to do anyway, Ben Bernanke, NY Fed Pres. William Dudley, and maybe the future vice-chairman Janet Yellen, all of whom combine a Keynesian taste for countercyclical moves with a Friedmanite understanding of the errors of the 1930s. They will take their time tightening in a period of low growth and low inflation according to Richard Hoey, chief economist of BNY-Mellon and The Dreyfus Funds.
He argues that any long-term structural risks like a future fiscal train wreck will not hit until 2013. The cyclical conditions would have to be the exact opposite of those prevaliling today. You would need to see high and rising inflation, restrictive (rather than expansionary) official monetary policy, and Treasury auctions being crowded out by strong croporate credit demand. Such factors may arise in 2014-6 but they do not exist today.
If you insist on buying low yield Treasury bonds, buy ones which are inflation protected due in 5 years or more.
The “union” trend affecting Chinese east coast factories producing for export with disputes over higher wages and better working conditions reflects a labor shortage. The workers come from the inland provinces which are shorthanded, an unintended consequence of the one-child policy imposed on China three decades ago. While China is not supposed to run out of young workers for another decade according to the tables, in fact the shortage is already emboldening dorm-hoursed workers making parts for Japanese and Taiwanese global manufacturers. One solution is for Chinese plants to open inland nearer to the home villages of young people with less gumption and get-up-and-go, who are less likely to down tools and walk out. Another solution is to find an alternative to China.
It may be months before the impact on commodity prices of slowing Chinese exports hits. But since much of the raw materials China imports are re-exported in the form of semi-finished goods or parts, the higher labor costs renminbi will cut imports as well as exports. This will reduce the appeal of commodity companies and currencies. Adjustments will be made in the portfolios during the summer to get ready for risign Chinese prices.
We have the first of a two part series on a country likely to replace some of China’s production in today’s paid blog. We also will think about how the new China will import less from Japan.
My apologies for leaving out a decimal point in Friday’s blog note about the huge gold coin sale in Vienna. It was bought for the exact equivalent of its gold content, one third below the auctioneers’ estimates, not 30% below.
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