Advisor Insider: No need to be so negative
As an investor, you are used to paying for wealth management services. You pay your broker to take care of your investment account. You pay someone to store your art, take care of your boat or look after your second home. So why not pay the government to keep your super conservative investment? Yes, I’m talking about negative-yielding debt.
At this moment in time, there is a whopping $17 trillion worth of government debt that is trading at negative yields. For years, many academics thought that such an event was impossible. After all, money has a cost. If you are asking for money to consume it today (government spending) and return it to me tomorrow, this incurs a cost.
Since the coming of the Industrial Age, governments have run deficits and developed a sophisticated system of funding their needs with public money. Most of the expenses are related to social spending on pensions, healthcare and others, most of which were originated at the beginning of the 20th century.
Investing in government bonds is seen as the safest investment, even more so if the bonds are issued in the currency of said government, as they can increase taxes and also print money to pay the bonds’ interests if need be. Most countries today have full yield curves that go from overnight all the way to 30 or even 100 years of maturity. This usually is the benchmark from which all other debt obligations of the private sector or quasi-sovereign institutions can price their debt. The shape of the yield curve also helps predict the health of the overall economy and the possibility of incoming recessions.
Upside down world
So if all of this is true, why are investors – mostly in Europe and Japan – willing to receive less back than what they invested when buying government bonds? In truth, there is no clear explanation, but I believe that a paper penned by Larry Summers and other economists can help shed some light on the topic.
The last century has brought a lot of advancements in healthcare and social services. People live longer and want to work longer but social services are also not what they used to be in many countries. This is leading people to save more and work longer as they are concerned that the State will provide less services in the later stages of their lives. This has created a savings glut in most developed economies, mainly by the baby boomers that are still producing and not retiring at the ages most statisticians expected. Since these savings are from older investors, it is only logical that their preference is for fixed income and very safe investments.
On the demand side, there is simply less. Companies are borrowing less capital than before, mainly for two reasons: they do not find a lot of projects worth investing in (today borrowers are mostly unicorns and not your traditional industrial companies) and many projects now are asset-light and require much less capital than before. Most new companies are in the services/information technology business, and they do not need to build a plant costing billions of dollars to produce goods. According to this study, the real rate of equilibrium should be about -4% yields!
However, thanks to the exercise of quantitative easing and significant US government deficits, the rate is only around 1%. But when we move to Europe with countries like Germany and France that have fiscal surpluses and lower deficits, this savings trend has led to negative rates.
Many in the market are dealing with the negative yield environment as it is a new phenomenon. They are also having to contend with a lack of liquidity despite the massive injections carried out by the world’s biggest central banks. But if we look at Japan, this situation has been going on there for almost two decades with no signs of it changing.
It is now prevalent in Europe and is clearly is moving to the US. This partially explains the rally of the dollar as people are coming to the US market, because for now, Treasurys are the only ones offering positive rates. But for how long? Difficult to say.
28 Octubre 2019