Investment Outlook: Interest Rates, Bonds - The Canary In The Coal Mine
"High fiscal deficits and higher outstanding debt lead to higher real interest rates and ultimately higher inflation, both trends which are bond market unfriendly." - IMF
The stock market rally off the March 2009 low caught most investors off guard. By year end the S&P 500 finished up over 26% while the TSX Composite index bested 35%. What you may not know is that corporate bonds, specifically high yield bonds, performed even better, and so far to the end of February 2010, they're leading the way again. A recent live webcast with PH&N's Hanif Mamdani, manager of their Lipper award winning high yield bond fund, suggests the party's not over, although, we are approaching the dawn.
In advance of the presentation, I forwarded to Hanif a copy of a recent New York Times article by Nelson Shwartz titled: 'Corporate Debt Coming Due May Squeeze Credit' and asked him to comment. The point of the article is that there is a record amount of corporate debt coming due in the next couple of years, close to a trillion dollars, which will need to be refinanced in competition with record government deficit spending and existing debt, which will also need to be (re)financed.
Hanif acknowledged that this is certainly a risk along with a large and unexpected rise in interest rates. I would argue that the two are not mutually exclusive. Check out this excerpt from Bill Gross of Pimco:
"In the U.S. in addition to the 10% of GDP deficits and a growing stock of outstanding debt, an investor must be concerned with future unfunded entitlement commitments which portfolio managers almost always neglect, viewing them as so far off in the future that they don’t matter. Yet should it concern an investor in 30-year Treasuries that the Congressional Budget Office estimates that the present value of unfunded future social insurance expenditures (Social Security and Medicare primarily) was $46 trillion as of 2009, a sum four times its current outstanding debt? Of course it should, and that may be a primary reason why 30-year bonds yield 4.6% whereas 2-year debt with the same guarantee yields less than 1%.
The trend promises to get worse, not better. The imminent passage of health care reform represents a continuing litany of entitlement legislation that will add, not subtract, to future deficits and unfunded liabilities. No investment vigilante worth their salt or outrageous annual bonus would dare argue that current legislation is a deficit reducer as asserted by Democrats and in fact the Congressional Budget Office. Common sense alone would suggest that extending health care benefits to 30 million people will cost a lot of money and that it is being “paid for” in the current bill with standard smoke, and all too familiar mirrors that have characterized such entitlement legislation for decades. An article by an ex-CBO director in The New York Times this past Sunday affirms these suspicions. “Fantasy in, fantasy out,” writes Douglas Holtz-Eakin who held the CBO Chair from 2003–2005. Front-end loaded revenues and back-end loaded expenses promote the fiction that a program that will cost $950 billion over the next 10 years actually reduces the deficit by $138 billion. After all the details are analyzed, Mr. Holtz-Eakin’s numbers affirm a vigilante’s suspicion – it will add $562 billion to the deficit over the next decade. Long-term bondholders beware." (Go to Pimco's website to read Bill's 'Investment Outlook ' in full. Another great article to read is 'Don't Be a Fool: Watch the Bond Market, Not Bank Lending or Velocity' by Damien Hoffman, Wall Street Cheat Sheet)
This is one ball you don't want to take your eye off of.
GB
The stock market rally off the March 2009 low caught most investors off guard. By year end the S&P 500 finished up over 26% while the TSX Composite index bested 35%. What you may not know is that corporate bonds, specifically high yield bonds, performed even better, and so far to the end of February 2010, they're leading the way again. A recent live webcast with PH&N's Hanif Mamdani, manager of their Lipper award winning high yield bond fund, suggests the party's not over, although, we are approaching the dawn.
In advance of the presentation, I forwarded to Hanif a copy of a recent New York Times article by Nelson Shwartz titled: 'Corporate Debt Coming Due May Squeeze Credit' and asked him to comment. The point of the article is that there is a record amount of corporate debt coming due in the next couple of years, close to a trillion dollars, which will need to be refinanced in competition with record government deficit spending and existing debt, which will also need to be (re)financed.
Hanif acknowledged that this is certainly a risk along with a large and unexpected rise in interest rates. I would argue that the two are not mutually exclusive. Check out this excerpt from Bill Gross of Pimco:
"In the U.S. in addition to the 10% of GDP deficits and a growing stock of outstanding debt, an investor must be concerned with future unfunded entitlement commitments which portfolio managers almost always neglect, viewing them as so far off in the future that they don’t matter. Yet should it concern an investor in 30-year Treasuries that the Congressional Budget Office estimates that the present value of unfunded future social insurance expenditures (Social Security and Medicare primarily) was $46 trillion as of 2009, a sum four times its current outstanding debt? Of course it should, and that may be a primary reason why 30-year bonds yield 4.6% whereas 2-year debt with the same guarantee yields less than 1%.
The trend promises to get worse, not better. The imminent passage of health care reform represents a continuing litany of entitlement legislation that will add, not subtract, to future deficits and unfunded liabilities. No investment vigilante worth their salt or outrageous annual bonus would dare argue that current legislation is a deficit reducer as asserted by Democrats and in fact the Congressional Budget Office. Common sense alone would suggest that extending health care benefits to 30 million people will cost a lot of money and that it is being “paid for” in the current bill with standard smoke, and all too familiar mirrors that have characterized such entitlement legislation for decades. An article by an ex-CBO director in The New York Times this past Sunday affirms these suspicions. “Fantasy in, fantasy out,” writes Douglas Holtz-Eakin who held the CBO Chair from 2003–2005. Front-end loaded revenues and back-end loaded expenses promote the fiction that a program that will cost $950 billion over the next 10 years actually reduces the deficit by $138 billion. After all the details are analyzed, Mr. Holtz-Eakin’s numbers affirm a vigilante’s suspicion – it will add $562 billion to the deficit over the next decade. Long-term bondholders beware." (Go to Pimco's website to read Bill's 'Investment Outlook ' in full. Another great article to read is 'Don't Be a Fool: Watch the Bond Market, Not Bank Lending or Velocity' by Damien Hoffman, Wall Street Cheat Sheet)
This is one ball you don't want to take your eye off of.
GB
Labels: Investment Outlook
posted by Gordon Bell at
10:52 AM
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