Ten Notes on the Current Market Scene

1) Start with the big one from yesterday.  On of my favorite monetary heretics, Raghuram Rajan, whose excellent book I reviewed, Fault Lines, pointed out how he had gotten it right prior to the crisis, versus many at the Fed who blew it badly.  Rajan suggests that Fed Funds should be at 2-2.25%, which to me would be a neutral level for Fed Funds.  That’s a reasonable level.  The economy needs to work its way out of this crisis, even if it mean failures of enterprises relying on a low short rate.  Entities that can’t survive low positive rates that give savers something to chew on should die.  Mercilessly.  Monetary policy at present is a glorified form of stealing from savers, who deserve more for their sacrifice.

2) Peter Eavis, an old friend, echoes my points on QE, in his piece Government Clouds Value of Investments.  When the government is actively trying to destroy the willingness to hold short-term assets, and engages in QE, it makes all rational calculations on investments a farce.

3) I agree with John Hussman in a limited way.  QE artificially lowers interest rates, which lowers the forward value of the US Dollar.  That doesn’t mean it will generate a collapse; I don’t think it could do that unless the Fed began to do astounding things, like monetize a large fraction of all debt claims.

4) The US Government is so dysfunctional that the baseline budget has increased 4.4 Trillion over the next 10 years.  This is the beginning of the end of the supercycle, and the reduction of America to the influence level of Brazil.  Earnings levels will converge as well, but more slowly.

5) While we are thinking soggy, think of Japan.  Years of fiscal and monetary stimulus have availed little.  Overly low interest rates have fostered an economy satisfied  with low ROEs.  Low interest rates coddle laziness, and encourage stagnation.

6) There are limits to stimulus, whether monetary or fiscal.  There is no magic way to produce prosperity by government fiat.  Stimulus, by its nature, will run into constraints of default or inflation, if taken far enough.  If not, why doesn’t the Fed buy up all debt?  (leaving aside laws) Isn’t QE a free lunch?

7) Deflation is tough; it weighs upon cities, states and other municipalities, who hide their true obligations.

8 ) Hoisington, the best unknown bond manager.  Where do they think long rates are going?  2% or so on the 30-year.  Makes the current buyers of bond funds look like pikers.  That’s over a 35% gain from here.  If they are right, their fame will be legendary.  Now, that could explain the willingness to fund ultra-long duration debt, because the gains will be bigger still.  What a great confusing time to be a bond investor, until something fails.

9) Or consider the Norfolk Southern 100-year bond deal yesterday.  Quoting the WSJ:

In what bankers hope will be the first in a new round of 100-year bond sales, Norfolk Southern Corp. raised $250 million Monday by selling debt that it won’t have to repay until the next century.

Investor interest was strong enough that the company increased the size of the new sale from $100 million. Market participants said investors had expressed an interest in buying at least $75 million of the debt before the company decided to announce the $100 million deal.

The interest rate on Norfolk Southern’s new debt is 6% for a yield of 5.95%, about 0.90 percentage points more than where the company’s outstanding 30 year debt was trading Monday. It was the lowest yield for 100-year debt bankers could recall, breaking through the 6% yield on the company’s 100-year issue in 2005.

“There is no question, obviously, that you are giving up a bit of liquidity, but you’re getting a pickup of 90 basis points to move out of the 30-year,” said Jeff Coil, senior portfolio manager at Legal & General Investment Management America. “But you’re getting good income on a stable cash credit in a sector where there are only a handful of rails left.”

Mr. Coil said the firm had a “sizeable” order in the deal. There were approximately 20 investors overall.

Moody’s Investors Service rated the new senior fixed-rate bonds Baa1, and both Standard & Poor’s and Fitch Ratings rated them BBB+.

Is 0.90%/year enough to compensate from going from 30 to 100 years?  I think so. The difference in interest rate sensitivity of a 30 versus a 100 are small at a yield of 5-6%, and if you have a liability structure that can handle it, as a life insurer might, it makes a lot of sense.  After all, a life insurer can’t economically invest in equities because of capital restrictions. You could compare it to investing in long dated preferred stock or junior debt, but then if there is a default, the losses are more severe than with a senior unsecured bond.

10) I’ve never found the yield curve model for recession/recovery compelling.  Limited data set, not covering the Great Depression, etc.

More to come.

3 Comments

  • so… ummm. are the pension funds buying NSC’s century bond at 6% yield adjusting their return assumptions down to 6%? or are they leaving them up at 7.5% – 8%? cause that is what’s boggling my mind…

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