Bond Outlook [by bridport & cie, January 14th 2009]
The situation in bond markets is developing much faster than usual. Our alert of October 2008, repeated last week, to take profits in government bonds and to move into quality corporates, has already become current practice, so much so that fixed-income investors are moving down the quality scale to, for example, new issues of single A bonds. A significant difference is emerging, however, between EUR and USD denominated issues. There are far more of the former and demand is currently keeping up well with supply. One consideration is that yields are higher in EUR so that any future widening of spreads would have less impact on the bond prices. Another is that Europeans are more at ease with companies they know (perhaps we should say the devils they know) than with US corporations now that the traditional big names like GE and the Government Sponsored Entities are no longer, or much less, available.
It is just possible that the term bubble will extend from government to investment-grade corporate bonds, but not yet. In both cases, a bursting bubble is misleading as it conjures up images of price collapses of tens of percent; the risk with both types of bond is much more measurable and limited. For the moment we are happy to let stand our recommendation of moving from governments to corporates, especially in EUR and CHF.
Paulsons original plan of buying out the toxic assets from banks to put them in a bad bank is making a come-back. Bernanke endorsed it in his London speech on January 13 and the proposal is again being reviewed by the UK Treasury. Moreover, that is more or less the approach being adopted by Citi Group in its restructuring.
Beyond the individual tactical moves by governments to forestall a depression, we have a major concern about the strategic approach. As we observed last week, much to the intervention by the US Government (and to a lesser extent elsewhere) is more of the same Greenscam remedy of not allowing the natural readjustment process brought about by economic forces after overheating or bubble bursting. We admit to being Keynsesian like everyone else, but we also endorse a strong dose of Austrian economics. Maybe we should call ourselves Schumpeterist. We certainly like his concept of creative destruction, which is the exact opposite of Greenscamism, a term that succinctly describes US economic policy: if an enterprise or an industry is failing, let it die. Then resources can move to new wealth-creating activities. Schumpeters concept applied mainly to industrial enterprises, which makes many wonder whether saving the US auto industry is worth it. He may not have thought through what happens if banks are allowed to fail and wreck the economic system. Obviously the US Administration had not done so either in letting Lehman go bankrupt. Yet that is not to say banks should always be bailed out. The post-Lehman practice of government participation and forced marriages seems a smarter idea. Not so smart is the concept of turning the finance arms of industrial enterprises into banks by injection of new capital by the Treasury and then allowing the new banks to issue debt guaranteed by the Fed (à la GMAC). Incidentally, GMAC has lowered its standards for car loans; a new sub-prime saga for auto loans?
One of Schumpeters remarks looks very prescient:the intellectual and social climate needed to allow entrepreneurship to thrive will not exist in advanced capitalism; it will be replaced by socialism in some form. Are the current government policies in the advanced economies an aberration or a fulfilling Schumpeters forecast?
The heart and soul of Greenscamism is not to allow a lowering of the standard of living of the US population, or, rather, to strive not to allow this outcome. It has happened anyway, and will continue to happen. As we have affirmed many times in this Weekly, no country, not even one with the worlds main reserve currency, can continue indefinitely to live beyond its means. This basic truth is now exerting itself, as the USA, along with the UK, Ireland, Spain, Greece, Iceland and others, are finding out the hard way.
We expressed our disappointment with Bernanke many months ago when he proved to be a Greenscam Mark II. He has even taken the policy further by allowing the Fed to buy T-Bonds (beyond the normal open market operations). We cannot help remembering the disaster such practice brought on France between the wars; monetising government debt is like printing money and leads to inflation. Bear this in mind even as the world goes through a period of deflation; the swing from deflation to inflation could be very sudden.
(+) Germany: a stimulus plan of EUR 50 billion to include investments in the school system and the automobile sector of EUR 1.5 billion. Tax reductions are also expected
(!) UK: record trade deficit in November at GBP 8.33 billion versus GBP 7.63 billion in October, the largest since date were first collected in 1697. A GBP 20 billion scheme being set up for loans to SMEs
(?) Ecuador: despite the threat of default on Global bonds, the Finance Minister will meet interest payments on the 2015 government bond, just as they did the last time that they threatened not to pay
() Ireland: the Republic is asking for funds from the IMF
(+) positive for bonds () negative for bonds (!) watch out (?) begs the question
Recommended average maturity for bonds.
Relatively short. Prefer corporates over government.
As of 8.10.08
As of 16.07.08
Dr. Roy Damary