What hath God wrought? Morse's words were echoing through my mind this morning as I was searching for attractive bonds to purchase for a new client of my asset management firm. But, instead of God, I inserted the name Jerome Powell into that sentence.
We are in an interesting time in the bond market, where every maturity from two to 30 years on the U.S. Treasury scale is trading below par. Using the standard convention of a "synthetic" bond with exactly 10 or 30 years left shows us how radically the yield curve has been elevated since last summer's depths. So, bonds issued then are not worth face value anymore, and you could buy them now and lock in a slight capital gain if you held to maturity. But who does that? Well no professional trader in the bond market, that's for sure.
These aren't Jed Clampetts telling Granny, "We are rich!" because they struck oil. They are professional traders measuring the risk of the bond's current yield to maturity with the risk that that yield could be eroded by inflation, which would require that bond to be re-priced downward to produce an attractive return. It's an interesting game, and the movement in that game toward a yield of 1.50% (and briefly 1.61% last week) from last March's low of 0.38% has been deleterious for the valuation of tech stocks. Watch out for that phenomenon. I believe it will continue, no matter what Powell and his global cronies due to artificially inflate bond prices.
But with the COVID crash aside, the clear picture on long-term interest rates is downward, really for the past 35 years. Countries like Germany and the Netherlands now show yield curves with the majority of maturities below 0% and there are corporate issuers in those countries issuing zero-coupon corporate debt, which is, frankly, nuts. Governments can print money; companies can't. There is always some risk, even for the bluest of the blue chips.
But that's where we stand. A world in which deflation is a bigger risk than inflation? That world does not exist. I have spent 11 hours on flights this morning, and I can attest to that with my own eyes. Gas prices are much higher than they were at the end of 2020, housing prices have been going through the roof, and I am returning from Brazil, a country where the local news is reporting that prices of rice -- a dietary staple -- are up 77% year-on-year.
So, where does Powell live? Where does he buy his gas? And where does Janet Yellen get her hair cut? No, seriously, what the hell is wrong with these people? Global central bankers are pouring fuel on an inflationary fire that was eminently predictable to burn once the world corralled COVID-19, which is occurring in some places (although Sao Paulo is entering a new, stricter lockdown phase Friday.)
Inflation is making people's lives worse ... except for those who hold risky assets. Like stocks for instance. That is what is happening. So, the bond market -- which is always more "with it" than the stock market -- has noticed, and Treasuries are being dumped. I am eagerly awaiting the next round of alchemist bullish from Powell and his cronies ...OK, actually, I am not.
The cost of money is rising. And, damn it, it should have never been that low to begin with. It is hard to start up a new company (try doing it in Brazil, as I am, if you don't believe me). It is hard to create economic value (returns on capital above the cost of that capital) and it is hard to fight rising input costs. It is no easier for Tim Cook today than it was for Steve Jobs in the 1980s. But prevailing interest rates are so much lower now. It's just Fantasy-land asset-pricing driven by central bankers.
So, money printing can greatly reduce risk of default, but it increase the risk of erosion of value driven by inflation, not decreases it. Less-valuable money used to pay off ever-increasing indebtedness is a stupid way to run a business, and an even stupider way to run a global economy. Google "Weimar" of you don't believe me.
So, where to hide out? Energy companies benefit from inflation, as do agricultural firms and banks benefit from a steepening yield curve. Look at a chart of Exxon (XOM) vs. the Invesco fund (QQQ) over the past three weeks. The market is telling you to take risk off the table and to rebalance your tech-heavy portfolio. Listen to Mr. Market... and ignore Mr. Powell.
