Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Ian Lance, manager of the RWC Enhance Income fund, looks at ten reasons why financial markets are behaving strangely.
What is going on in financial markets strikes us as more bizarre than anything we have ever experienced in our life time and yet it has been going on for so long it has now become accepted as the norm and as such never really attracts any comment.
The Chinese tech sector now trades on 220 times earnings
Of course, all this craziness can be traced back to the same source; bubble loving central banks who believe the way to cure too little aggregate demand is to send prices of all financial assets to the moon. Below we highlight ten things that suggest the lunatics really have taken over the asylum.
1. $3.6 trillion of government debt, or in other words nearly a fifth of all global government debt, is now trading with a negative yield and yet a few weeks ago EPFR data showed inflows to all fixed income funds of $16 billion – the highest on record going back to at least 2008.
This is despite repeated warnings from regulators about the lack of liquidity in bond markets and the fact that the actions of the European Central Bank are making liquidity even worse.
2. €2 trillion of Euro area government bonds over one year maturity have negative yields and yet Mario Draghi thinks if he can just get interest rates down a bit further he can turn the European economy around.
The reality is that the ECB is playing the role of the greater fool providing an exit to those hedge funds and prop desks who have bought bonds with a negative yield to maturity – that is anyone buying bonds with a guaranteed loss to maturity – can only be doing so in the belief some ‘greater fool’ will buy them at a higher price, a greater loss to maturity.
At the first sign that the ECB is going to taper its purchases, this money will stampede for the exit at the same time with some interesting results.
3. Japan is now printing money to buy equities. According to The Wall Street Journal; “The Bank of Japan’s aggressive purchasing of stock funds has helped Japanese shares climb to multi-year highs in recent months. But some within the central bank are growing uncomfortable about the fast-paced rally and the bank’s own role in fuelling it.”
Since Governor Haruhiko Kuroda took office in March 2013 and introduced monetary easing of what he called a “different dimension,” the central bank has sharply increased its buying of exchange-traded funds. By directly underpinning the market, officials have tried to encourage private investors to follow suit and put more money in stocks in the hope of stimulating the economy and increasing inflation.
During the past two years, the central bank entered the stock market roughly once every three days, picking up a total of ¥2.8 trillion ($23 billion) of ETFs that track Japan’s major stock indexes, according to Bank of Japan records. That distinguishes it from the U.S. Federal Reserve and European Central Bank, both of which have bought bonds to pump up the economy but haven’t directly bought stocks.
4. The fact that the S&P500 is close to its all-time high would tell you the US economy is firing on all cylinders and yet the Federal Reserve seems frightened to remove emergency monetary policy seven years in to the recovery.
Janet Yellen removed ‘patient’ from the Federal Reserve’s statement but promptly rushed to assure financial markets that this didn’t mean she was ‘impatient’ to raise rates. As has been the case with every announcement from Chairman Yellen since she took over, the market was immediately sent in to raptures.
5. In 2007, global debt of $142 trillion was enough to nearly blow the financial system to smithereens but seven years later global debt stands at $199 trillion and nobody seems to believe this is an issue.
6. In 2009, General Motors emerged from government backed bankruptcy; the total cost of the GM bailout to the U.S. taxpayers was $12 billion. A group of hedge funds have recently taken a stake in the company and have come up with the brilliant idea of GM gearing itself up again.
The company has instantly capitulated and announced it is authorizing an immediate $5 billion stock buyback, and plans to return all cash above a $20 billion floor to shareholders. Another victory for ‘activist shareholders’.
Some companies that have been leveraging up their balance sheets for a while, have now hit the point where anymore debt will result in them being downgraded to junk status. Viacom announced on April 6 2015 it would have to cease its share buyback in order to stay within its ‘target leverage ratio’.
7. The Shanghai Composite has once again breached the 4,000 level and has nearly doubled in less than twelve months. The outstanding balance of margin debt on the Shanghai Stock Exchange surpassed ¥1 trillion in April, a fourfold rise from twelve months ago.
The real excitement, however, has been in the Chinese technology sector which now trades on an average 220 times earnings but where stocks such as Beijing Tianli Mobile Service Integration is up 1871% from its October IPO and is valued at 379 times earnings.
8. Whilst bond yields, commodity prices, the Baltic Dry Index and inflation expectation are all collapsing and suggest deflation could be an issue, equities have decoupled and continue to rise suggesting it is not.
9. As the yield on corporate bonds of companies such as Nestle and Royal Dutch Shell goes negative, money continues to flow in to corporate bond funds. Even more bizarrely, a sex therapist in Denmark called Eva Christiansen has just achieved notoriety in becoming the first person to take out a bank loan at a negative interest rate.
Ms Christiansen has borrowed money for three years from Realkredit Danmark at minus 0.0172 meaning that the bank will pay her DKr7 every month for the loan.
10. Spanish political party Podemos is tipped to win the Spanish elections on an agenda of debt cancellation, and public control of the banks and energy companies. Spanish youth unemployment is 50% and debt to GDP is 92% and yet the ten year bond yield is 1.16% and the stock market is up nearly 80% in two and a half years. On April 7, Spain joined the ‘negative yield’ club and managed to issue €725 million of six-month debt at -0.002%.
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