When it comes to bonds I have four main ideas.
- Invest in areas where you are more than adequately compensated for the risks.
- Try to be as unconstrained as possible.
- After a credit crash, wait for the momentum to return to credit, and pile on.
- During a time of debt deflation, be willing to hold long-duration high quality debts.
Those are my strategies and simple enough.? But what do I do when they are disagreeing with each other?? I play for time.? I play my best ideas, and wait for the market to make a big move that I can ride.
I have owned long duration Treasury bonds for the past year, but have not owned them only, but other ideas as well.? Being long credit has worked, whether in:
- Floating rate loans,
- Long duration corporates, or
- Bank preferred stocks
That does not mean I did not have my failures.? I lost a decent amount of money expecting that the Swiss National Bank [SNB] would eventually break its peg versus the euro.? I still have a small bet on that, and still expect that I will make money on the trade, as the position of the SNB is becoming more difficult by the day.
My goal as a fixed income investor is to make money.? Unlike most fixed income investors, my goal is to make a lot of money when it is favorable to do so, and tread water the rest of the time.? I?m treading water now.? Rates are low; yields are low ? there aren?t that many distortions to take advantage of.
I await an environment with more opportunities.? I wonder if this is how Seth Klarman feels toward the end of a bull market.? I?m just schnitzeling, and waiting for some real opportunities to show up.
As it is, I use two proxies to guide me: AGG and CSJ.? My performance over the last year was between the two.? In the short run, I look to exceed CSJ.? In the long run, I look to exceed AGG.
Full disclosure: long CSJ
Any thought on end of year cliff with congress?
Too speculative. As it is, the bond market might better off going over the cliff in the short run. Stock market, not so good.
Think the odds are 1 in 4.
I agree on the SNB. How do you play that? Long FXF?
long FXF, yes.
In what way is the SNB’s situation “getting more difficult”?
Do you have a scenario in which the undisclosed difficulty could cause an operational issue that will prevent continuation of the peg? Running out of their infinite supply of CHF perhaps? I guess we could say that you are short infinity.
If nothing else, given that they still have a deflation problem, it would make sense for them to tighten the peg, to say 1.15, and there’s no operational reason they can’t do that if they wish to.
The commitment could expose the SNB to massive losses. It is holding massive quantities of euros, whose value has steadily declined in Swiss franc terms. We are talking 100s of billions in potential losses if the market tests them, which it will eventually
The “massive losses” are possible but irrelevant. Imagine all euro assets the SNB holds go to zero tomorrow morning: it would be a total non-event. It just makes their capital account negative which as such is no problem for a central bank, because it can operate with infinite negative capital for an infinite duration. The balance sheet for a central bank running a fiat currency has no solvency value, it’s just a way to record its history.
The market therefore has nothing to test. Let’s imagine you could command 100% of the liquid capital in the world to this task, you still couldn’t take down the SNB: you’d just end up with 100% of the world liquid capital as a CHF denominated cash balance at the SNB to your name, and the SNB in turn owning all world assets that you have just sold to them to acquire those CHFs. The value of those assets is in essence irrelevant to the SNB’s ability to do its job.
The “market test” situation only applies when a central banks want to support an exchange rate in the other direction, that is when they need real assets (be it foreign currencies) to buy their currency to support its value, in which case they can indeed run out of assets, which is what the market can and does test.