Crazy European Bond Market

[audreyh1]

The total video requires a subscription to watch, but the interesting part as rates go negative the price of the bonds becomes like a hockey stick and since index funds, are market capped as the long maturity zero coupon bond increases in price they become a larger percentage of the index, leading to more buying as incremental funds are added. Now of course this also leads to large future potential volatility, a tendency to outperform managed funds as they do not buy these assets because of their negative expected return, but the built in negative expected return is a certainty over time, which is why passive index funds are about the only buyers, because passive investors do not by design calculate values based on expected returns. But in the short term more and more turn to passive funds as they are over performing a valuation method.

Some bond index funds target a specific duration range as their benchmark.

 

[Running_Man]

Some bond index funds target a specific duration range as their benchmark.

Most 401K fund investing from people age 30 and under is retirement date funds, that for a retirement 2050 looks like the following: about 3% in foreign bonds of 9 percent in total

By the time you get to 5 years from retirement the holdings are:

Vanguard Total Stock Market Index Fund Investor Shares 37.00%
Vanguard Total Bond Market II Index Fund** 27.40%
Vanguard Total International Stock Index Fund Investor Shares 24.20%
Vanguard Total International Bond Index Fund Investor Shares 11.40%
100.00%.
https://twocents.lifehacker.com/when-to-opt-out-of-the-target-date-funds-in-your-401-k-1830435912
"In fact, “68 percent of millennials are 100 percent invested in a target date"

Almost all new money being invested by young people is going into target date funds and so the allocation to foreign bonds and equity is only going to increase over time. This will allow negative bond yields to become the defacto choice as money to invest in them will be growing, leading to an increase in their percentage as their market cap appreciates faster. Indeed when a central bank purchases their long dated bonds at very low interest rate, this causes funds to buy MORE of their bonds not less because as a percent of the index they are climbing, leading to even lower rates which continues the process, and Central Bank buying leads to a shortage which leads to higher prices which leads to even more purchases, it is utterly insane yet true....

As long the young investors do not pull out their money, this means stocks and bonds will have the ability to go to unimaginable heights, and the circumstances that led to no interest bonds going up 50% in a month will continue and spread to stock because any sales by a value investor because of expected returns is overwhelmed by the new young investors who are 90-96% committed to passive investing and have a holding period of forever, making active managers looking at expected returns look foolish and losing their jobs as their funds dwindle. In such a universe prices will go up in a self-confiming bias, until there is a market moment that causes investors to wish to lower equity holdings.

https://www.cnbc.com/2018/06/12/millennials-are-dumping-their-individual-stocks-and-flocking-to-etfs-schwab-survey-shows.html

Presently this is not as big of an issue because older retirees are less invested in passive investing and active investing holds a larger part of the assets right now but as the passive pool becomes larger than the active pool, the lack of value analysis by the holders of equity will reduce the amount of stock available for sale at a price at the margin and reduce the amount of buyers at a lower price. Years with 50-60 percent advances in the coming decade I believe are a very real possibility, as is the possibility for 50-60 percent down in an incredibly short period.

 

[pb4uski]

The total video requires a subscription to watch, but the interesting part as rates go negative the price of the bonds becomes like a hockey stick and since index funds, are market capped as the long maturity zero coupon bond increases in price they become a larger percentage of the index, leading to more buying as incremental funds are added. Now of course this also leads to large future potential volatility, a tendency to outperform managed funds as they do not buy these assets because of their negative expected return, but the built in negative expected return is a certainty over time, which is why passive index funds are about the only buyers, because passive investors do not by design calculate values based on expected returns. But in the short term more and more turn to passive funds as they are over performing a valuation method.

But you would think that the bond fund index managers could still replicate the index while at the same time avoiding these known losers... IOW you don't necessarily have to buy every bond in the index... just enough to replicate the index... so don't buy any zeros at a premium--- period. If all the funds put into place a rule like that then there would be no demand for zero coupon bonds below par and it wold effectively create a floor of par for zeros.

DS is in a couple Vanguard target date funds in his tIRA and Roth... I think I'll suggest that he divest the target-date funds and just buy the stock and domestic bond funds instead.

 

[Running_Man]

But you would think that the bond fund index managers could still replicate the index while at the same time avoiding these known losers... IOW you don't necessarily have to buy every bond in the index... just enough to replicate the index... so don't buy any zeros at a premium--- period. If all the funds put into place a rule like that then there would be no demand for zero coupon bonds below par and it wold effectively create a floor of par for zeros.

DS is in a couple Vanguard target date funds in his tIRA and Roth... I think I'll suggest that he divest the target-date funds and just buy the stock and domestic bond funds instead.

But it is likely those negative yield bonds will actually be the best performing bonds and would subject their investors to underperformance, leading to passive managers that do
invest in negative yields. The larger and far more interesting point to me is this is moving on into the stock universive. The negative yielding bonds only proved this point because they owned almost the entire issue showing what can and will happen in the stock universe over time.

 

[OldShooter]

Most 401K fund investing from people age 30 and under is retirement date funds, that for a retirement 2050 looks like the following: about 3% in foreign bonds of 9 percent in total

By the time you get to 5 years from retirement the holdings are:

Vanguard Total Stock Market Index Fund Investor Shares 37.00%
Vanguard Total Bond Market II Index Fund** 27.40%
Vanguard Total International Stock Index Fund Investor Shares 24.20%
Vanguard Total International Bond Index Fund Investor Shares 11.40%
100.00%.
https://twocents.lifehacker.com/when-to-opt-out-of-the-target-date-funds-in-your-401-k-1830435912
"In fact, “68 percent of millennials are 100 percent invested in a target date"

Almost all new money being invested by young people is going into target date funds and so the allocation to foreign bonds and equity is only going to increase over time. This will allow negative bond yields to become the defacto choice as money to invest in them will be growing, leading to an increase in their percentage as their market cap appreciates faster. Indeed when a central bank purchases their long dated bonds at very low interest rate, this causes funds to buy MORE of their bonds not less because as a percent of the index they are climbing, leading to even lower rates which continues the process, and Central Bank buying leads to a shortage which leads to higher prices which leads to even more purchases, it is utterly insane yet true....

As long the young investors do not pull out their money, this means stocks and bonds will have the ability to go to unimaginable heights, and the circumstances that led to no interest bonds going up 50% in a month will continue and spread to stock because any sales by a value investor because of expected returns is overwhelmed by the new young investors who are 90-96% committed to passive investing and have a holding period of forever, making active managers looking at expected returns look foolish and losing their jobs as their funds dwindle. In such a universe prices will go up in a self-confiming bias, until there is a market moment that causes investors to wish to lower equity holdings.

https://www.cnbc.com/2018/06/12/mil...and-flocking-to-etfs-schwab-survey-shows.html

Presently this is not as big of an issue because older retirees are less invested in passive investing and active investing holds a larger part of the assets right now but as the passive pool becomes larger than the active pool, the lack of value analysis by the holders of equity will reduce the amount of stock available for sale at a price at the margin and reduce the amount of buyers at a lower price. Years with 50-60 percent advances in the coming decade I believe are a very real possibility, as is the possibility for 50-60 percent down in an incredibly short period.

Sigh ... all based on the impossible ideas that young investors do or will comprise a significant factor in the market and that their investing behavior will never change.

 

[Running_Man]

I now believe passive investing will by definition of the market forces continue to outperform active investing and I see no reason this trend will not continue to accelerate. Passive assets are up almost 10X in the past 10 years, outperforming the growth in active assets by 5X, the differences in growth already appear exponential vs linear. The interesting part for prices is the point where investing reaches the tipping point and moves become much larger as passive investing o totally dominates a market segment as they did the negative European bond market this summer.

I see absolutely no plausible explanation for an end to this trend other than a major market malfunction.