Jim Grant: The Endgame for the Bull Market in Bonds


I like this.


By James Grant, Barron’s

President Trump’s Tuesday morning ultimatum that the “boneheads” at the Federal Reserve do something to materialize negative nominal interest rates again prompts the question, “Where does it all end?” In monetary debasement, a bond shakeout, and higher gold prices, of course.

Your columnist has been saying this for years. But it’s a much more striking line of argument when it runs out under the byline of Rick Rieder, BlackRock ’s full-time bond investor and part-time blogger.

In a Sept. 5 post, Rieder speculates on the “monetary endgame.” Inasmuch as a bond is a promise to pay money, the monetary topic could hardly be weightier.The 38-Year Case for BondsYields on long and short-term bonds have steadily fallen after peaking in 1981.Source: Bloomberg%30-Year3-Month1985’90’952000’05’10’15’20-5051015

Philipp Hildebrand, former head of the Swiss National Bank and a colleague of Rieder’s at BlackRock, scooped the Rieder message in a Sept. 3 op-ed in the Financial Times. Come the next recession, Hildebrand proposes, let the monetary authorities directly infuse citizens with money, rather than futilely continuing to whack away at the stubble of the world’s bond yields. Anyway, whatever the economic merits of the Hildebrand plan, it sounds like a vote-getter.

Taking up the argument on Sept. 5, Rieder, too, makes a case for the efficacy of helicopter money, the kind that enters the payments stream without passing through the banks. Figuratively speaking, it flutters to earth from the doors of low-flying aircraft—an image that Milton Friedman dreamt up and that Ben S. Bernanke alarmingly invoked while he was a Federal Reserve governor. Competitive currency devaluations, too, stand to figure in the monetary grand finale, Rieder speculates.

How to invest for this endgame? “As is probably evident,” the BlackRock chief investment officer for global fixed income leads off, “any nominal instrument will be devalued in real terms, so the solution is to hold an asset that maintains its real value—an asset that cannot be printed. We would include stocks (dividend yields are set on payout ratios, companies have some degree of pricing power, and shares outstanding are limited in number), real estate (it is difficult and expensive to expand the stock of real estate), and even commodity currencies like gold (again, limited supply and expensive to extract).”

The worst asset to hold in this hypothetical bonfire of the currencies? A “sovereign bond with a negative yield, closely followed by paper money at zero yield, both with a theoretically infinite supply.”

So says the man near the top of a firm that, at the end of the second quarter, held $2.19 trillion of fixed-income securities. Have the clients heard?

You’ve heard all the reasons put forward to buy bonds, even the ones yielding less than zero. Plunging birth rates, burdensome debts, dwindling union membership, perpetually subdued inflation, and the price-chopping works of Jeff Bezos constitute only the preface to the sales pitch. It’s a bullish narrative as deeply ingrained in the market today as the bearish one was a generation ago.

I hold in my hands a relic from a fateful year in interest rates. It’s an analysis by J. Parker Hall III published in the May-June 1981 issue of the Financial Analysts Journal: “Shouldn’t You Own Fewer Long-Term Bonds?” is the wry, beckoning headline.

As every schoolgirl knows, 1981 was the culmination of the post-World War II bear bond market. Long-dated Treasury yields peaked at 15%, up from the long-forgotten 1946 low of slightly over 2%.

In retrospect, you can see that 1981 was to bonds what 1849 was to gold, but with this difference: Whereas any California forty-niner could comprehend a gold nugget, it took the likes of Hall to spot the value in bonds.

A longtime trustee of the University of Chicago and president of Lincoln Capital Management, Hall was Midwestern investment royalty. He spoke with authority, but it took all his powers of persuasion to make the case for bonds, the long-dated kind, no less, in the wake of the inflation-seared 1970s.

“The 1979-80 bond debacle,” Hall wrote near the summit of the yield mountain, “appears to have represented a final cataclysmic adjustment, as 15 years of traditional hopes about future lower inflation were demolished and replaced by present untraditional fears about future higher inflation. For the first time in our history, bond investors have given up.”

Hard-won investment experience had taught them that, whatever they might have learned in school, bonds made poor portfolio diversifiers and were even more susceptible than stocks to extreme price volatility. Then, too, there was no reason to bear the risk of long-duration assets when they yielded less than Treasury bills. And if all that weren’t enough, Hall had to admit that “owning bonds is embarrassing.”

Or had been embarrassing. In investing, the author wisely continued, “price is nearly everything.” Compare and contrast the 15% yield to maturity on senior securities with the 4.5% dividend yield on common stocks.

Price is nearly everything—and nearly every financial phenomenon is cyclical. Hall invited his readers to recall the stock-market collapse of 1974, only seven years in the past. “But stocks still provided returns of 18% compounded from 1975 to ’80,” he reminded them. In the previous six years, bonds provided a compounded annual rate of return of just 4%. “Is a differential as large as this a good indication of future normal comparative returns?”

Perhaps not even Hall envisioned the fixed-income future in all its splendor. Bond yields made their high around September 1981. In the 30 years until its maturity in 2011, the long-dated Treasury generated a compound annual return of 11%, edging the S&P 500 total return (including reinvested dividends) of 10.8% per annum.

Hall died in 2011, but I wonder what the Chicago grandee (an accomplished jazz pianist and tennis player, on top of everything else) would say now? I expect he might warn against drawing a too facile comparison between 1981 and 2019—between a proven historical upside record in yields and what may or may not turn out to be a reciprocal downside limit.

But his contrarian turn of mind might lead him to observe that the central bankers might yet succeed in their quest to stoke inflation, that the politicians are promising the voters the sun, the moon, and the stars, that bond yields tend to rise and fall over multidecade intervals and that $14.7 trillion of bonds nowadays yield less than nothing. “Shouldn’t you own fewer long bonds” he might ask, this time really meaning it.

James Grant is founder and editor of Grant’s Interest Rate Observer


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