Investors aren’t limited to only investing in the S&P 500 and the Dow Jones Industrial Average. Every week we share the market trends we are following. We are interested in whether the trends in those markets are continuing or if they are experiencing a temporary or complete reversal.
When we identify trends, we are only concerned about the price data and what it says about any given market. We don’t need to know why a trend has formed to invest, but our human nature wants to understand what is driving them. Each week we try to offer some perspective on what we think the most substantial moves are and what critical drivers are behind them. Here we look at what is going in our globally diversified, non-correlated Crystal Bay Ubitrend strategy.
Last week’s continuing trends:
- Russell 2000 Index
- Chinese Yuan
- Maize
- Soybean Meal
- Wheat
Last week’s reversing trends:
- Brazilian Real
- Orange Juice
- Russian Ruble
- Singapore Equities
- US Interest Rates
What we are taking note of:
The relentless decline in global interest rates continues. Government bonds used to provide risk-free return. Now they deliver return-free risk. A great example is Greek government bonds, which are, as of last week, yielding less than 1% for the 10-year bond.
In the middle of the Eurozone crisis in early 2012, those same bonds were yielding over 35%. Why such a dramatic turnaround? Did Greek government finances improve substantially since 2012?
Alas, no. Greek public debt to GDP ratio rose from 160% in 2012 to 177% in 2019. External debt to GDP stayed flat at 237% in the same period. The current account deficit improved from 3.8% in 2012 but still remains at a negative 1%.
By all measures, Greece is in a worse position than it was in 2012. By the end of 2019, before the coronavirus pandemic struck, GDP was 20% lower than in 2012, and 44% of all bank loans were non-performing. Greek GDP is forecast to shrink by another 10% in 2020.
And yet, capital markets are happy to price Greek government bond yields at only 20 basis points (0.2%) above US Treasuries.
Greece 10 year Government Bonds – January 1, 2020 – October 12, 2020
It is no mystery why. The markets assume that Greek government debt is effectively guaranteed by the European Central Bank (ECB). Despite years of denials and mixed messages from the ECB, if push comes to shove, creditors assume that they will be made whole, and the cost of default will be shifted onto the rest of the EU.
This may very well be fine as a solution for Greece, but Spain’s finances are in the process of collapsing as well, and Italy is not looking so good either. The size of the problems in these two countries dwarfs Greece by an order of magnitude. Italian government debt, by itself, is the 3rd largest in the world behind the US and Japan. The rest of the EU does not have the resources to provide a bailout to Italy and Spain. The EU guarantee may not be as rock solid as it seems.
None of these scenarios are priced in the market. The desperate scramble for yield, any yield, by bond investors around the globe has led to absurd mispricings. What is the probability that there will be no debt crisis in Greece in the next ten years? The market says it is less than 10%, and hundreds of billions of euros are at risk if it turns out to be incorrect.
How are we heading into next week?
The same story is repeated in countless corners of the global bond markets, from high yield corporate debt to bank loans to government debt. Bond investors are receiving no compensation for the risks they are bearing. Institutional investors such as insurance companies or pension funds have to continue investing at these levels because regulatory mandates and institutional constraints leave them no option.
But individual investors are not subject to the same limits, and they are free to throw away the old 60/40 bond allocation straightjacket. Now is the time to do so.