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Crazy European Bond Market
Old 07-20-2019, 11:27 AM   #1
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Crazy European Bond Market

Austria just sold 100-year bond, at a price of 154 and a coupon of 2.1% at par. If held to maturity, the yield is 1.171%. What is the chance of inflation being below 1.171% for the next 100 years? And what keeps the Austrian government from recalling the bond, causing the bond holder to immediately lose 1/3 of his principal? Assuming no inflation, it will take 26 years of 2.1% interest to recoup the 54% over par that you pay.

An article below points out that perhaps the above 100-year bond is still better than Austrian 5-year bond, which has a yield of -0.435%. Yes, there's a minus sign. And more, the Austrian bond is still better than German bond yet, which has a yield of -0.643%. Again, note the minus sign.

On another front, Greek 10-year bond now has the same yield as the US bond. An expert points out that “Greece is rated B+ by Fitch, has a debt-to-GDP ratio of 181%, a youth unemployment of 40.4%, and its nominal GDP has shrunk by 23% in the past decade. Greece has defaulted eight times and has been in default for half of its time as an independent country.”

I think we are heading into an exciting time.


See:

Barrons.com - Global Bond Markets Are So Crazy

Marketwatch.com - If the stock market is irrational, what do you call the bond market?

Financial Times - Greek bond yields lower than US Treasuries
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Old 07-20-2019, 11:57 AM   #2
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From The Economist back in 2017:
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And European investors such as pension funds and insurance companies need to buy bonds for regulatory reasons; indeed, as the yield on bonds falls, they have to buy more bonds, not fewer. This may be driving bond yields down below the level that economic fundamentals suggest. The same pressures do not apply in America.
This is one example of why I don't favor index funds that include a lot of bonds (or equities) that are not subject to normal free-market pressures. To the degree that true price discovery is thwarted (through governmental policies, etc), it makes less and less sense to include these assets in index funds. To me, many of the European bonds are an example of this, as well as Chinese A Shares, etc.
This, obviously, is a matter of degree. There are some regulations on the sale/purchase of virtually every type of asset. But the greater the market distortion, the less I trust passive investing in that asset (or, even, investing at all in that asset. It's hard to guess what the regulators will/won't smile on in the future.)
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Old 07-20-2019, 12:33 PM   #3
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Yes. Who would want to buy these bonds, unless there's a gun held to his head.

It's just one of the ways for the government to take the wealth from people who have, e.g. pension funds and other institutional investors. A more common way is to issue more money to use inflation to achieve the same effect.
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Old 07-20-2019, 02:56 PM   #4
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Yes. Who would want to buy these bonds, unless there's a gun held to his head? ...
I suspect it is mostly portfolio managers of underfunded pension plans. IIRC there was a 100 year, 8%, dollar-denominated Argentinan bond that quickly sold out sometime last year.

The pension fund manager then gets his bonus for increasing the yield of the portfolio and he hopes to be gone when the chickens come home to roost.

I have never understood why individuals would be buying junk or international debt using the "safe" side of their AA.
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Old 07-20-2019, 03:58 PM   #5
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But these European bonds are not junk bonds. They have negative yield, not high yield.

The more you buy, the more you are guaranteed to lose. There's not a sliver of hope, as with junk bonds. It sounds like they have to buy them and cannot stay in cash, nor are they allowed to buy US treasuries for example.

I do not know how European finance laws work, but it is perplexing.
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Old 07-21-2019, 07:51 AM   #6
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a high risk of default ( a total loss of capital , a delay or failure to pay interest as promised or a 'hartcut ' that is a partial repayment of capital ) makes it 'junk ' to me , an interest rate of less than 12% simply makes it unattractive to me .

just because some of these EU bonds have 'sovereign ' in fromt of the description doesn't remove them from my assessment of junk ( high on that list are Greece , Cyprus , Spain and Italy ).

the recent Greece and Cyrus sagas prove the European laws are anything that saves face at the ECB
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Old 07-22-2019, 02:03 AM   #7
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The more you buy, the more you are guaranteed to lose. There's not a sliver of hope, as with junk bonds.
Well, technically, you could win if interest rates decline further. And yes, we've been told for several years that they couldn't possibly go any lower. They could.

Quote:
It sounds like they have to buy them and cannot stay in cash, nor are they allowed to buy US treasuries for example.

I do not know how European finance laws work, but it is perplexing.
Some investors do have to buy bonds, as outlined by other posters above. Another motivation for large financial institutions to purchase these is the following: Banks have to pay 0.4% in interest for the funds they hold at the ECB. And there is a cost involved with holding large quantities of cash, too.
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Old 07-22-2019, 07:19 AM   #8
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There are now about a dozen junk/non-investment grade bonds with negative yields.
Some buy these expecting gains when interest rates drop even further... with a plan to sell them to "the greater fool" when they want out of the market. But what happens when nobody wants to buy high risk+negative return investments?

Meanwhile there are only TWO AAA rated corporate bonds in the US: Microsoft and J&J.
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Old 07-22-2019, 08:04 AM   #9
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When I see something like this I have a REALLY hard time understanding how Vanguard is recommending Intl Bonds as part of ones bond portfolio.

Anyone know whey they would recommend this? Their total intl bond fund currently is 56% in europe.

I realize they currency hedge this, but still HOW could any reputable firm recommend an allocation including something that has negative yields
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Old 07-22-2019, 08:55 AM   #10
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Well, technically, you could win if interest rates decline further. And yes, we've been told for several years that they couldn't possibly go any lower. They could.
"My bond is worth more than your bond, because my yield is only -1% while you pay -2%" ?

Quote:
Some investors do have to buy bonds, as outlined by other posters above. Another motivation for large financial institutions to purchase these is the following: Banks have to pay 0.4% in interest for the funds they hold at the ECB. And there is a cost involved with holding large quantities of cash, too.
Oh, these poor Europeans.
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Old 07-22-2019, 08:58 AM   #11
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Originally Posted by BeachOrCity View Post
When I see something like this I have a REALLY hard time understanding how Vanguard is recommending Intl Bonds as part of ones bond portfolio.

Anyone know whey they would recommend this? Their total intl bond fund currently is 56% in europe.

I realize they currency hedge this, but still HOW could any reputable firm recommend an allocation including something that has negative yields
I guess if you are indexing, you have to buy everything whether it makes sense or not. Dotcoms, banks that deal in CDO, it all goes in your shopping basket. Bitcoins are next.
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Old 07-22-2019, 09:04 AM   #12
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Originally Posted by BeachOrCity View Post
When I see something like this I have a REALLY hard time understanding how Vanguard is recommending Intl Bonds as part of ones bond portfolio.

Anyone know whey they would recommend this? Their total intl bond fund currently is 56% in europe.

I realize they currency hedge this, but still HOW could any reputable firm recommend an allocation including something that has negative yields
Mario Draghi was clear that he had no intent to raise interest rates. Christine Lagarde, who will be his successor has indicated she intends to continue along the same path and has stated that she believes negative interest rates are good for the economy.

You're being told that the central bank has no intent to raise interest rates. Recommending bonds in such an environment is not so ridiculous.
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Old 07-22-2019, 09:05 AM   #13
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Originally Posted by BeachOrCity View Post
When I see something like this I have a REALLY hard time understanding how Vanguard is recommending Intl Bonds as part of ones bond portfolio.

Anyone know whey they would recommend this? Their total intl bond fund currently is 56% in europe.

I realize they currency hedge this, but still HOW could any reputable firm recommend an allocation including something that has negative yields
Its no different than cracking open the holdings of US bond funds and finding a pile of the top holdings are from Illinois. Technically the BBB- rating with a negative outlook is still "investment grade".
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Old 07-22-2019, 09:07 AM   #14
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Mario Draghi was clear that he had no intent to raise interest rates. Christine Lagarde, who will be his successor has indicated she intends to continue along the same path and has stated that she believes negative interest rates are good for the economy.

You're being told that the central bank has no intent to raise interest rates. Recommending bonds in such an environment is not so ridiculous.
Isn't there a really big caveat of recommending bonds to trade vs. to hold to maturity?
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Old 07-22-2019, 09:11 AM   #15
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Originally Posted by NW-Bound View Post
"My bond is worth more than your bond, because my yield is only -1% while you pay -2%" ?

Oh, these poor Europeans.
Well, of course the point is that the central bankers want the money to be spent/invested, not held. The bogyman is deflation, where buyers expect stuff to be cheaper in the future so do not spend and the economy stagnates.

Re bond funds and index bond funds and international bond funds I guess this just confirms my bias against buying bond funds. They are really very different animals than equity funds.
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Old 07-22-2019, 09:12 AM   #16
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I guess if you are indexing, you have to buy everything whether it makes sense or not.
If you are indexing you still need to decide what assets in which you'll invest. My criteria would be:
1) Expected return (after expenses)
2) Expected volatility
3) Correlation of volatility with my other assets
4) Do the prices reflect true free-market exchanges (wide knowledge of valuation factors, free of a regulatory thumb on the scale, etc )
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Old 07-22-2019, 09:18 AM   #17
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Well, of course the point is that the central bankers want the money to be spent/invested, not held. The bogyman is deflation, where buyers expect stuff to be cheaper in the future so do not spend and the economy stagnates.
Surely central bankers want people to put their money to use, instead of hoarding it.

But you have to ask why people are so afraid of deploying their money. Why are they so reluctant to invest in their business, buildings, factories, machinery to improve production, to better their living conditions? Sounds like they have a gloomy outlook on the future. If so, why?
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Old 07-22-2019, 09:33 AM   #18
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Surely central bankers want people to put their money to use, instead of hoarding it.

But you have to ask why people are so afraid of deploying their money. Why are they so reluctant to invest in their business, buildings, factories, machinery to improve production, to better their living conditions? Sounds like they have a gloomy outlook on the future. If so, why?
The business investment corollary is why do so many companies find the best investment of their (borrowed) capital is buying their own stock back ($1.1T in 2018) vs. investing it in new plants/equipment/etc?
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Old 07-22-2019, 09:34 AM   #19
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Isn't there a really big caveat of recommending bonds to trade vs. to hold to maturity?
Certainly there is. However, if you purchase a long-dated bond and today the central bankers are telling you they will not be raising rates for the foreseeable future, at some point you'll likely be able to sell for a profit, while collecting interest in the interim.

It's not for me. However, I can certainly appreciate that it may be for some investors.
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Old 07-22-2019, 09:54 AM   #20
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The business investment corollary is why do so many companies find the best investment of their (borrowed) capital is buying their own stock back ($1.1T in 2018) vs. investing it in new plants/equipment/etc?
Yes, the above is what US corporations do. They don't know what to do with the money, or do not know what risks to take. They could have raised dividend payout, but stock buyback boosts stock price and gives management beaucoup income via bonus and options. Shareholders are happy to see share price go up.

Not that the above is good, but do European corporation management practice this?
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