These Actions are the Last Resort for Yield Pigs

These Actions are the Last Resort for Yield Pigs

These Actions are the Last Resort for Yield Pigs

Governments involved in financial repression (keeping savings rates below the inflation rate) encourage their citizens to do stupid things by reaching for yield.  Remember, most people think of yield as a magic chicken that lays eggs on schedule, and never gets sick or dies.  Those who truly understand markets know that yield is an allocation of free cash flow, and that many businesses can’t control their free cash flow, so dividends are less than fully certain.

And so, I’m skeptical of the focus on income investing.  With bonds, I am not as skeptical, because there is a promised, though not guaranteed return of principal.  That doesn’t mean there aren’t problems there.  We are having a record year for issuance of corporate bonds.  Abbott Laboratories (NYSE:ABT)  is offering a huge deal.  My experience with huge deals is to avoid them, unless there is some special reason to play, kind of like the last bond deal from Household International in 2002, where I bought and then traded them away for the 3o-year non-deal protected bonds bigtime.

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That said, I get concerned over:

China has low interest rates for savers, so many Chinese turn to Wealth Management Products in order to earn something decent on their money.  Many of them may be little different than a Ponzi scheme.  When governments do not allow savers to earn rates exceeding inflation, savers turn to all manner of products that could harm them, both legitimate and illegitimate.

The same thing goes on in Malaysia with their Gold Plans, and suchlike.  But let’s keep things simple: let’s invest in the best corporate bond investment out there: long Baa bonds.


What’s that I see?  We’re at a 50-year low for yields on low investment-grade-rated bonds.  Surely the economy should be booming.

What, like the Great Depression, we are in a liquidity trap?  Seems that way.  Additional capital finds rare incremental productive uses, and often the best use is shrinking the company by buying back stock.

Part of that stems from the folly of the Federal Reserve using its balance sheet to buy up all manner of high quality debts by expanding its balance sheet — its cost of finance is 0% (maybe, wait till the losses come, they came to Fannie and Freddie).  By doing so, they distort pricing in the debt markets, favoring issuers over lenders, favoring the government over the private sector.

It leads to nothing good, because increasingly marginal projects get financed.  As in Japan, the marginal efficiency of capital fell dramatically, and has not risen for two decades plus.  Though it would have been painful it would have been better to have more failures and longer recessions 1986-2007.  The Fed should have kept rates higher for longer.  We would have normal markets today if they had.

As I have said before, investors don’t do well when they don’t have a place to park excess money for a small real return.  I’m not looking for the ’80s, when the return was often huge, but something above inflation, fairly estimated.  Until then, the misguided plans of the Fed will continue to do little, as businesses look at the low marginal efficiency of capital, and shrink their operations.  Remember, when businessmen see economic policies that can’t persist, they don’t take advantage of the situation — they pull in their horns and become defensive.  Thus the budget deficits, QE, and the ZIRP lead to a slower economy in the intermediate-term.

By David Merkel, CFA of Aleph Blog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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