Bond markets

The Biggest Iceberg Of Unrecognized Risk

It’s a ship-killer.

While we obsess about the stock market, an even-bigger financial challenge is possibly looming in the future. Yet few people are paying attention.

Debt has once again risen to outlandish proportions. Especially, state-driven debt and pension obligations may have reached a level which is impossible to pay back.

Read more about yet another state’s financial struggle here.

Why don’t we clearly know if these massive commitments are fundable?

Because we don’t know how much the economy will grow in the future.

Also we don’t know if sanity will emerge and spending will be reduced.

And, finally, we don’t know what actuaries will define as future contribution requirements for the large pension plans.

All this has deep implications for our economy and especially our bond markets. As investors, diversification is key, since we can’t really know where and when debt defaults might occur, if ever.

To help with this, we’re keep municipal bond investors diversified into nation-wide municipal bond mutual funds and not just state-of-residence-only mutual funds. Yes, you’ll pay a bit more taxes, but you’ll probably be safer.

In the taxable bond arena, we’ll keep most of our long term bonds in our asset allocation funds, so the managers have a non-bond place to run if a crisis suddenly pops up.

Most likely we’ll simply muddle by, as tends to happen. Patience, courage, and discipline.

Have a great weekend.

Why the economy isn’t thriving: more insight

Last week we were in San Francisco listening to a presentation by Schwab’s chief economist, Liz Ann Saunders. My takeaway was that the economy is not thriving because of

a. excessive debt in the system.
b. complexity.

The excessive debt may or may not have prevented a depression but its legacy is gargantuan payments to keep from defaulting. These will only become larger as interest rates rise.

The complexity is due to technological change and off-the-charts over-regulation. Distractions have grown and regulatory uncertainty is rife.

What will happen? We don’t know. Here’s bond guru Bill Gross’ latest comment.

Is inflation the only way out?

At the end of a busy day of study and action, I’m looking at overall debt loads and interest rates. I’m wondering if, perhaps, the US government might seek to “accidentally” create runaway inflation for a short period to reduce the real cost of their soaring debt load. Otherwise, when interest rates go up, it’s going to be very difficult to repay. It worked for Germany in the 1920’s. No, wait, it didn’t work, did it? Still, it will be tempting when the bills come due.

Explore German hyper-inflation here.

Out of energy, into financial stocks.

We have largely exited our energy holdings. Most of these were profitable. We have cut our gold exposure in half after a very successful run. Our overall holdings in technology and health care remain in place. Now we are newly invested in bank stocks, both foreign and domestic. The challenge of financial stocks currently is that they are a very uncertain and high-risk position, dependent upon both interest rates rising and economies not stalling. We can’t really guess what will happen. For example European bank stocks…of which we own a dollop…were hammered today with bad Euro-economic news (Is there any other kind?) I’m thinking that patience and humility may help us produce outsized gains in this unloved, ignored sector. Meanwhile billionaire bond trader Jeff Gundlach says sell everything, even the kids. I’m inclined to keep the kids. Stay patient.

Read this article simply to see what billionaires think is happening…and it’s not pretty. 

Singapore’s Sovereign Fund is expecting what the bond markets are already predicting

That would be at least a decade of slow growth. The article is attached. As I read this, I’m struck by how fortunate we are that we didn’t go to cash back when it seemed that cash was best. I’m interpreting this article as a prediction (and you know how well those work) that index funds won’t uniformly perform optimally. (That’s investment-speak for “They might lag.”). There will still be very attractive sectors, if we have the wisdom to see them and the courage to invest in them.

Read the article here.

What the 30 year Treasury bond is telling us.

On Wednesday, the government auctioned off $12 billion in U.S. Treasury 30 year bonds for the astoundingly low interest rate of 2.172%. These are taxable bonds. This means that the investors in these bonds expect essentially no economic growth in the U.S. in the next thirty years.

Consider what 30 years of “steady state” economic growth would mean.

It would mean that the stock market indexes should stall where they are or rise until the average dividend is lower than bonds, although individual issues should do well. Index funds gonna suck.
It means that we should all save much much more because average investment returns will be small.
It means that they don’t expect interest rates to rise ever. Cash and C.D’s will have zero return for the next thirty years.
It means the American Middle Class will stagnate or fade. Upward mobility will require either luck, educational prowess, or unique skills in wealth creation.
This suggests, that, should this interest rate be an accurate indicator, there will be substantial social unrest, perhaps even revolutionary movements, as the American economy withers and American frustration grows. All the central bank interventions and sweeping economic policies haven’t worked.
It seems to me that this is the biggest news of all. After all, there can’t be economic justice for any economic or ethnic group if the entire economy is fading.
Or investors are wrong, and this bond market is simply overpriced, and in a bubble.
We will only know by living through this. Eat your veggies.