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Guest Post: A Bubble In ‘Safety’ Driven By Bond Funds?

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Submitted by Pater Tenebrarum of Acting-Man blog,

A Bubble in 'Safe Assets'?

Bloomberg recently published an article on a report by Seth Masters, the chief investment officer of Bernstein Global Wealth Management, entitled “Desperately Seeking Safety”. Masters argues that bonds, gold and 'safe' stocks are all 'dangerously overpriced'. To be sure, we at least partly disagree with this thesis on the grounds that first of all, one cannot simply regard all these assets as belonging to the same class. The temptation to do so stems mainly from the fact that they have risen in parallel for a long time due to  specific historical circumstances. However, if we e.g. look back to the 1970s, we can see that these assets can often take completely different paths. It all depends on the precise type of economic and market upheaval the world is experiencing.

Moreover,  the pricing of these assets reflects the ongoing uncertainty in a world that is in the grip of the lunacy of policymakers who have seemingly lost all sense  of perspective and are engaged in a huge gamble. This essential fundamental backdrop has not changed for the better lately, but for the worse. Masters has to assume that these crazy policies will somehow 'work' all of sudden in order for his argument to fully stand up.

However, we do in principle agree with a number of points he makes – such as e.g. the fact that one's future returns are highly dependent on where in a price cycle one buys, and that any asset can become too expensive at some point. We also agree with him that massive stock buybacks don't produce better or 'safer' stocks.

In fact, it is our experience that stock buybacks usually surge at precisely the wrong moment, leaving balance sheets precariously overstretched when the time comes in which balance sheet strength might be highly desirable.

We want to briefly look at a particular aspect of the 'safety bubble' here, namely its expression in the stock market. Below are three randomly chosen long term charts of stocks that are usually considered nigh 'recession-proof' and are deemed highly reliable dividend payers.

 

JNJ

Johnson & Johnson – a stock that is widely regarded as 'recession-proof'- click to enlarge.

 


 

PG

Procter & Gamble – the same holds for this stock- click to enlarge.

 


 

WMT

Wal-Mart also belongs to the class of 'safe stocks' – click to enlarge.

 

It is no secret what is driving the buying in these stocks – it is the aforementioned uncertainty that is the main motive behind it. Investors are still seeking 'safe havens' and stocks like the ones depicted above fit the bill. However, the incessant buying over recent years has undoubtedly reduced the margin of error associated with owning these stocks. They may be 'safe', but how safe can they really be once they have become this expensive? With regard to this, Masters certainly has a point.

As an aside to all of this, gold is obviously also no longer the bargain it was in 1999/2000 and bonds no doubt look overstretched as well. The main difference between gold, bonds and the stock market is that the former two are assets that according to recent surveys are hated with a passion by investors, while stocks are currently getting more love than ever before in history.

 

Who Is Buying?

In the above context we have come across another very interesting recent article in the WSJ that may at least partly explain who it is that is so desperately paying up for 'safe stocks'. Apart from deluded central bankers, bond funds are increasingly straying from their reservation and are piling into equities. Bond funds, writes the WSJ, are 'running low on bonds' these days.

“The number of bond funds that own stocks has surged to its highest point in at least 18 years, another sign that typically conservative investors are taking bigger risks to boost returns.

 

Regulators generally allow funds to hold a mix of assets, but the scale of bond funds' shift into stocks is unusual, fund experts said, and could expose investors to unexpected losses. In all, 352 mutual funds that are classified by Morningstar Inc. as bond funds held stocks as of their last reporting date, up from 312 at the end of 2012 and 283 in the first quarter of 2012, according to the investment-research firm.

 

The rush into stocks illustrates the dilemma bond investors face. The bond market has rallied for much of the last 30 years, and yields, which move in the opposite direction of prices, stand near record lows.

When bond-fund managers buy stocks, "They're reaching for yield," in the form of dividends, said Russ Wermers, a finance professor at the University of Maryland who studies mutual funds”

(emphasis added)

'Reaching for yield' rarely works out well. We are not sure when that phrase was originally coined, but it became incredibly popular in 2006 and 2007 to describe the rush into all sorts of 'structured products' like ABS, CDOs, CPDOs, high yield bonds, PIK bonds and so forth.

As noted above in the WSJ article, this rush into equities by bond funds 'could expose investors to unexpected losses'. We would actually rephrase that: it will expose them to unexpected losses with near certainty.

 

Bond funds holding equities

Bond funds holding equities – an 18 year high (chart via the WSJ)

 

Conclusion:

What this once again demonstrates is that intervention by central banks is creating incentives for many institutional investors to take inordinate risks in the name of preserving the purchasing power of the savings that have been entrusted to them. This is inter alia a symptom of what happens when central banks are holding interest rates well below their natural level. In the real economy, malinvestment of capital occurs on a grand scale, while investors are increasingly taking risks they would usually shy away from.

This is of course a declared goal of current central bank policy: namely to encourage risk taking, whether or not it is sensible. The problem is that the gains of today are absolutely certain to become the losses of tomorrow for investors taking the bait, as the echo bubble created by loose monetary policy is fated to turn into a major bust once the boom has played out. When the tide is going out, a great many naked swimmers will be revealed.

This time we believe that the coming bust will shatter the last bastion of investor faith: the illusion that central banks are omnipotent and can 'fix' the economy and markets by waving their 'magic wand' in the form of the printing press.

 

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Fri, 05/03/2013 - 20:15 | 3529058 UH-60 Driver
UH-60 Driver's picture

Whilst you're buying bonds, swing by and pick up some Crystal Meth too.  You'll need it.

http://www.youtube.com/watch?v=wRUbNruP0FU

 

 

Sat, 05/04/2013 - 09:20 | 3529850 Spigot
Spigot's picture

I have always seen "The Bubble" as being at its root a Debt Bubble, or Credit Bubble, either way.

Sat, 05/04/2013 - 11:07 | 3529950 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

One continuous bubble. From tech to housing to stocks to bonds to student loans and etc....... No where to blow left.

Fri, 05/03/2013 - 20:16 | 3529075 fonzannoon
fonzannoon's picture

I remember back when I was young and somewhat less stupid in 2001 and tech crashed and clients came in with their "value funds" and their "growth and income funds" which were all up 35% the prior year and they said "how come my fund is getting killed...it's a growth and income fund...growth and income funds don't own tech inside them". I remember the squirming that took place in my chair.

I swore that would never happen again. Good to see it's happening again.

Fri, 05/03/2013 - 20:21 | 3529079 Ban KKiller
Ban KKiller's picture

Counter party risk...either it is there or not. 

Brokers just churn the shit until it turns to butter....for them. 

Fri, 05/03/2013 - 20:26 | 3529090 fonzannoon
fonzannoon's picture

I recently moved my office. I get to the new buliding and the walls are paper thin. I have a fuckin old school chop shop next door. Every 5 minutes we hear "HELLO MR. SHLONGFACE? iT'S JOEY CHOPSHOP....OUR FIRM IS MOVING ON A RECOMMENDATION....I TRUST YOU HAVE A PEN HANDY".

It makes my physically ill when i hear it, and these young douchebags drive benz's. What amazed me is that they close accounts. People out there still fall for this shit. We are actually going to do this all over again. It's unreal.

Fri, 05/03/2013 - 20:35 | 3529111 nmewn
nmewn's picture

The drop in 2008 happened when I was thirteen, I'm eighteen now and much smarter than my parents ever were ;-)

Sat, 05/04/2013 - 08:30 | 3529821 RealFinney
RealFinney's picture

I was smarter than my parents back when I was 18, but every time I see them they seem to have learnt so much more...

Sat, 05/04/2013 - 08:32 | 3529822 RealFinney
RealFinney's picture

dup.

Sat, 05/04/2013 - 19:51 | 3530706 WhiteNight123129
WhiteNight123129's picture

Mark Twain: " When I was a boy of fourteen, my father was so ignorant I could hardly stand to have the old man around. But when I got to be twenty-one, I was astonished at how much he had learned in seven years. "

Fri, 05/03/2013 - 20:40 | 3529122 surf0766
surf0766's picture

There is only one thing that has always put the break on it over the past 4 years. Avg gas at $4.00. Everytime gas comes close to that avg the economy comes to a halt.

 

Housing is on the market near me. No one is buying and prices are being dropped.  I know one house which sold for 195,000 3 years ago. They dumped over 100K into it. Asking price started at $324,000. The price is now down to 259,900.

 

But we are in recovery...

 

Fri, 05/03/2013 - 20:21 | 3529081 Monedas
Monedas's picture

The only counter party risk to gold .... is your own death !

Fri, 05/03/2013 - 20:24 | 3529086 Yen Cross
Yen Cross's picture

 Sovereign Bonds> ROL-LAMAO)

Fri, 05/03/2013 - 20:25 | 3529089 putbuyer
putbuyer's picture

5 straight POMO Days next week

Fri, 05/03/2013 - 20:27 | 3529098 dick cheneys ghost
dick cheneys ghost's picture

''They'' might need them......Israel just kicked it up a notch in Syria.......

Fri, 05/03/2013 - 20:57 | 3529168 fxrxexexdxoxmx
fxrxexexdxoxmx's picture

Which G-d do you think will win? 

Fri, 05/03/2013 - 20:30 | 3529093 Yen Cross
Yen Cross's picture

v  We need some "Bill Gross", isms'...

  PIMCO/https://www.allianzlife.com/ Has your back!

Fri, 05/03/2013 - 20:29 | 3529102 All_Is_Well
All_Is_Well's picture

parabolic?

Fri, 05/03/2013 - 20:42 | 3529129 Wanton1
Wanton1's picture

Contrary to the postulations in this pitiful article, our collapse is no accident.

Fri, 05/03/2013 - 21:13 | 3529204 W T F II
W T F II's picture

Agreed...!!

Fri, 05/03/2013 - 20:49 | 3529148 hooligan2009
hooligan2009's picture

central banks are attempting to reduce the risk of any and all investments. they expect that this can be accomplished by stabilising returns, in other words, reducing the volatility of returns (risk) across the entire economy. perhaps it was warranted by the financial crisis, but where is the crisis now? no banks are failing, all banks are funded by cnetral banks and have no need to trade with each other.

central bank actions now have little to nothing to do with a financial crisis and more to do with the morphing of capital markets failure into an economic crisis, i.e. central banks are papering over a depression in employment.

negative returns increase risk faster than positive returns. (ever wonder how a doubling of the stock market can result in option vols at lower levels than halving of the stock market?).

the suppression of risk is the path to communism/full state control and enables mobocracy (the creation of a numerically larger number of "voters" with diminished prospects and less and less money.

if the central banks treat a reduction of risk as a primary goal, only low risk/low return investments will be available. 

in a world without central banks, individuals assess the risk and demand the return. individuals would not lend money to projects without sufficient compensation for risk.

where the central banks suppress risk, individuals lose the right to demand a return. why do central banks think that it is "right" to force lending rates below the risk premia demanded for inflation and time? 

simple, because they are instructed what to do by politicians elected by the same people who have become disabled by the suppression of risk. 

Fri, 05/03/2013 - 21:03 | 3529179 fxrxexexdxoxmx
fxrxexexdxoxmx's picture

+100 every clear and correct

Sat, 05/04/2013 - 11:11 | 3529957 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

The 4th turning is here. Winter and all its chill. The new order will replace this corrupt rotting corpse. What will the next order be? That is up for us to decide.

Fri, 05/03/2013 - 21:10 | 3529195 W T F II
W T F II's picture

I completely disagree. I believe central banks are propping the asset values to crash them. Knowingly. It is the only way to 'sell' the concepts that they must for what is coming. They are almost ready for the 'risk-off' phase.

Fri, 05/03/2013 - 21:07 | 3529185 W T F II
W T F II's picture

Really comical is the fact that many bond funds own each other's ETFs. Check the disclosure documents..!!

Any parabolic price curve ALWAYS ends badly, no matter the asset class. A commodity style sell-off in "blue-chip" dividend stocks will be something to behold.

Plus, most "investment managers" (we usually REALLY mean "relationship stewards"...) and their clients (even the "sophisticated" ones) know little of 'bond math' (i.e. convexity). Another unintended consequence of ZIRP is a set up for a catastrophic 'total return' nightmare. When you have nominal coupons of 1% or even fractional, changes in yield basis in the negative are wickedly destructive to $ price 'valuations'. When Tom, Dick, Harry and Mary see their NAVs fall precipitously, they are going to freak out... It WILL happen...More fodder for another element of the larger 'Panic Cycle'.

Fri, 05/03/2013 - 21:12 | 3529202 Monedas
Monedas's picture

The government won't let us see our gold .... the CBs won't let us see our gold .... the metals funds won't let us see our gold .... the Crimex won't even let Harvest Organ see the gold .... Bob Pissani can't see all the gold .... the coin stores don't have any to show .... the mints don't have any .... and I won't let you see MY FUCKING GOLD .... THAT ABOUT SUMS IT UP !

Fri, 05/03/2013 - 21:18 | 3529215 Yen Cross
Yen Cross's picture

 I would be selling P&G. That's a {shooting star} if I ever saw one.

Fri, 05/03/2013 - 21:24 | 3529229 Monedas
Monedas's picture

That's why it's called Proctologer and GAMBLE ! You bet your ass !

Fri, 05/03/2013 - 21:34 | 3529255 Monedas
Monedas's picture

Yen, I don't want to trade on your personal friendship with Tyler .... but did you see the Kaiser Report :   "PAPER JIHAD" .... put in a good word for me ?      Monedas    1929       Comedy JIHAD World Tour

Fri, 05/03/2013 - 21:48 | 3529274 Monedas
Monedas's picture

"I'm the son of a first generation, lower middle class family .... who has seen better days !" .... paraphrased and comically enhanced from Drei Grosschen Oper (Three Penny Opera) 75th Anniversary, Director's cut, German National Film Archives DDR, Ost Berlin, Zipspin copy on Frye's cheapest DVD $9.99 free shipping !   Learn more 1 (800) 555 - 5555 !

Fri, 05/03/2013 - 22:21 | 3529354 Wilcox1
Wilcox1's picture

Trying to understand in this reach for yield discussion if capital appreciation of the stock is part of the yield? 

Fri, 05/03/2013 - 22:43 | 3529402 Monedas
Sat, 05/04/2013 - 01:14 | 3529616 polo007
polo007's picture

http://news.goldseek.com/GoldSeek/1367608346.php

Because of excessive government interference with interest rates, those desperate for income—including pension funds—have pushed prices of virtually all secure sources to nosebleed heights. When the Fed eventually does raise interest rates, the bond bubble will be pricked and the stampede to get out of bonds should be like a herd of elephants attempting to exit through a revolving door. What to do in such a bond market crisis? Aside from TDL's blue-chip recommendations, we always recommend dispersing assets in several "friendly" countries. Also, diversifying in golds and silvers, including Saint-Gaudens double-eagle gold coins, rather than just keeping capital entirely in fiat currencies.

The world is in what we call "The Second Great Depression," comparable with the first one, in the 1930s. As laid out in my final business book, "Goldbug!," doubling the money supply in 1922 to pay for World War I caused a great inflation that after 1929 was corrected by the First Great Depression, in the 1930s. The similar printing of enormous quantities of paper money, not backed by anything except more paper, has also resulted in the current Great Deflation, still deepening, worldwide. The soup kitchens of the 1930s have been replaced by food stamps, but the resemblance is not coincidental.

Realizing that Keynesian economics failed to end unemployment after the 1932 crash, until World War II began around 1940, enabled us to predict with specific clarity that it would not work these days either. Indeed. Historically, large quantities of printing-press money has failed to reduce the downward trend of Americans with jobs in recent years. Few believed our prediction of "The Coming End of the Age of Jobs," or that it would lead to "The Coming New Social Order," but it is already unfolding. Unemployment in Europe already ranges between 20% and 50%, depending.

It is difficult for investors to protect themselves in this situation, but we cover it as best we can. We have recommended blue-chip stocks that have a dividend yield higher than that of U.S. Treasury paper, because they are proxies for institutions seeking to park their cash in areas other than overpriced bonds. That should end when the Federal Reserve finally allows interest rates to rise, but its fanaticism in continuing to suppress rates despite the Keynesian method not working represents a triumph of hope over experience—and will not end well.

Especially shocking is the delusion that adding inflation to a deflation would somehow cancel each other out, but is in fact the futile attempt to cure a problem with its cause. Overprinting paper runs at increasing risk of an eructation of "hyperinflation"—please note it is a word not used anywhere in the mainstream press these days. Predicting a hyperinflation is so daring in today's environment that we might be mistaken, so we will have to get closer toward the end game to be more confident of it. We hope we are mistaken.

Sat, 05/04/2013 - 10:26 | 3529905 Fiat Burner
Fiat Burner's picture

Stop copying and pasting articles in every thread. Just post the link with a one line summary. 

Sat, 05/04/2013 - 10:18 | 3529899 astoriajoe
astoriajoe's picture

The death of surety...coming up.. Followed by the GCE.

Sat, 05/04/2013 - 11:26 | 3529954 khakuda
khakuda's picture

I don't agree with this simplistic analysis.  Walmart, for example, trades at about 13.4 times next year's earnings.  The company's stock peaked in 1999 at 55 times trailing earnings - now that was a bubble.  The stock went nowhere for a dozen years, paying a dividend all along the way and growing earnings at a 10-11% compound rate annually with no help from Bernanke whose policies killed their customers with high gasoline price and generally no stocks/bonds/real estate to make them feel wealthy.  Earnings aren't particularly cyclical and are not at some excessive level of margin.  Can the stock back off a bit because it's ahead of itself?  Sure.  Is it dangerously overvalued?  If we go into a depression, market valuation can drop, but people are unlikely to stop buying groceries from the largest and cheapest supermarket in the world.

Sat, 05/04/2013 - 19:48 | 3530702 WhiteNight123129
WhiteNight123129's picture

PLease define safe asset.

Safe asset does not exist, Gold is not safe, Treasuries are not safe, nothng is safe. THere are things safer or riskier than other given the likely outcomes and their probability.

Maybe a tentative safety definition is an asset with no imminent failure and yet lopsided profit potential.

Where is the return positively lopsided when buying Treasuries? Can we rule out imminent failure at all?

At 12% of central bank reserves, it is arguable wether gold is overpriced.

THere is too much debt to GDP = there are too many finanical assets to present goods.

Gold is undiscounted, not sensitive to interest rates, when total debt to GDP is sustainable again, it will be because nominal prices have massively increased.

Gold is not about safety, it is a real asset that outperforms when finanical assets shrink, and shrink they will in relative terms (yet they could go up in nominal terms).

 

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