Market dislocations occur when financial markets, operating under stressful conditions, experience large widespread asset mispricing.
Welcome to this weeks edition of “World Out Of Whack” where every Wednesday we take time out of our day to laugh, poke fun at and present to you absurdity in global financial markets in all it’s glorious insanity.
In April, Li Lu and Bruce Greenwald took part in a discussion at the 13th Annual Columbia China Business Conference. The value investor and professor discussed multiple topics, including the value investing philosophy and the qualities Li looks for when evaluating potential investments. Q3 2021 hedge fund letters, conferences and more How Value Investing Has Read More
While we enjoy a good laugh, the truth is that the first step to protecting ourselves from losses is to protect ourselves from ignorance. Think of the “World Out Of Whack” as your double thick armour plated side impact protection system in a financial world littered with drunk drivers.
Selfishly we also know that the biggest (and often the fastest) returns come from asymmetric market moves. But, in order to identify these moves we must first identify where they live.
Occasionally we find opportunities where we can buy (or sell) assets for mere cents on the dollar – because, after all, I’m a capitalist.
In this week’s edition of the WOW we’re covering global bond markets
In truth it was a challenge to decide what to bring to your attention for this week’s “World Out of Whack”. A challenge made all the more daunting by the plethora of “out of whack” events cascading into my crosshairs.
On that note, feel free to send me any market observations that are seriously out of whack.
Speaking of out of whack, I’ll share two quotes with you before we head into this week’s WOW – one a blast from the past, and the other from the present. The latter serves as a poster child for the reason that Britain decided to exit the sclerotic, out of touch, undemocratic, bureaucratic, shambolic, “fustercluck” that is the European Union.
And before you call those Brits who chose to leave the EU a bunch of uneducated, xenophobic, right-wing bigots, I ask you, how would you feel being ruled by a foreign and increasingly imperialistic power with attitudes such as this?
Now that the votes have been cast we can let the Brits go back to their tea and scones, and the Eurocrats can continue back-slapping each other, wasting millions banning kettles and toasters. Perhaps they’ve failed to take notice of the thousands of potential ISIS members who they’ve welcomed into the EU, and who are now blowing people up in the streets.
Our bent here is not however to opine on what should or shouldn’t happen but rather to profit from these market events. The UK leaving the lunatic asylum has sent markets into a tailspin, causing the rest of the inmates to become increasingly restless.
It didn’t take very long before we heard talk of Grexit, Fruckoff, Departugal, Italeave, Czechout, Oustria, Finish, Slobakout, Latervia, and Byegium took hold with only Remania staying.
In all seriousness, and as I mentioned last week:
“The macro landscape is shifting underneath as at warp speed, and in today’s world capital shifts in minutes. With the Blockchain it shifts in seconds.
The politicians and central bankers are increasingly behind the curve, scrambling to catch up and each and every turn sees them exacerbating and compounding problems.
Brexit should stand as a wake up call not only to central bankers but to the political class globally.”
The markets’ knee jerk reaction is based upon linear thinking. This thinking goes that the most liquid and most stable of all investments are government bonds.
The fact that government bonds have been in a bull market lasting three and a half decades has provided investors with a false sense of security. And even though we know that the longer any bull market persists, the greater the inherent risks. The markets’ perception is – of course – just the opposite.
So let’s look at how this is playing out in real time.
- Japan’s long yields are on the road to zero. The 40-year hit 0.08% and unbelievably over 80% of the JGB market is now sub-zero.
- And it’s not only Japan: the entire world is rushing into the “safety” of government bonds.
In an equally stunning move, Fitch, Moody’s, and S&P all decided it was time to put the UK in the naughty corner, adorned with a dunce hat by downgrading their debt from AAA to AA. The French will be overjoyed to see the Brits cut down to their rating level.
That the UK had a AAA rating prior to Brexit while sporting some pretty horrific numbers will, at some point in the future, likely form an entire chapter in a book written about this period in time.
Not that the rating agencies are of any use at all. But this is like having a company’s earnings falling and investors turning around wildly buying the stock. And so in this crazy world investors are rushing into UK gilts, pushing yields below 1% for the first time in its history.
Not to be left out, the Irish followed suit, pouring money into their sovereign bond market, pushing the yield to a record low.
Let’s examine this for a minute, shall we?
Sovereign nations can print money to pay for their debts. That is, if those debts are issued in their own currency.
Back in the good old days investors used to be concerned that the printing of money would wipe out the purchasing power of the currency. And so governments were constrained by the markets with yields more closely reflecting risks. This is why Zimbabwe no longer has a bond market.
Today the impossible is not only possible – it’s happening. The grease that oils this is belief. A belief in Central banks.
While investors lurch violently into the “safety” of government bonds, central banks are warming the digital presses for additional stimulus. Stimulus – like anything financial has a debit and a credit column – and it certainly doesn’t sit in the credit column but as the Mad Hatter so correctly points out: it’s only a problem if you believe it is.
These are some of the headlines:
- Brexit: Bank of England to boost post-Brexit markets with $460 billion
- Norway’s central bank provides $2.7 billion liquidity to banks after Brexit
“The Bank of England offered to provide more than 250 billion pounds ($347 billion) plus “substantial” access to foreign currency to ease any squeeze in markets and Governor Mark Carney said it would consider more measures if needed.
The U.S. Federal Reserve said it was ready to provide dollar liquidity through its existing swap lines with central banks, “as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy”.
“The Federal Reserve is carefully monitoring developments in global financial markets, in cooperation with other central banks,” it added in a statement.
The European Central Bank said it could provide additional liquidity and would protect euro zone financial stability, while the People’s Bank of China pledged to keep the yuan basically stable and said it would maintain ample liquidity.”
If we were to read a news article stating, “Man amputates leg in bid to run faster,” we’d laugh at the absurdity. And yet today we have a deluge of such articles to choose from in the financial media.
Investors sure aren’t buying sovereign debt for the yield. They’re buying it for the certainty – or at least the perceived security – and so I’m curious to know where are you seeking security?
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“The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. I am an Enemy to all banks discounting bills or notes for anything but Coin. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered.” – Thomas Jefferson