‘Return-Free Risk’

In a world where some $18 trillion in debt “boasts” a negative yield, bonds no longer offer risk-free return, but rather “return-free risk.”

So says Leon Cooperman who, apropos of nothing, but I feel compelled to mention it anyway, literally cried on national television last year at the prospect of an Elizabeth Warren presidency.

Cooperman’s characterization of the bond market, delivered in a September interview with Bloomberg, is apt. The fixed income universe is, of course, distorted beyond all recognition by years of ultra-accommodative monetary policy.

As discussed in “Yen And The Art Of Bridge Maintenance,” we’ve reached the point of no return, at least as far as central banks’ capacity to let the market determine the price for assets like Italian government bonds. Without a concurrent acceleration in global economic activity that sets the stage for the fundamentals to rapidly “catch up,” allowing price discovery to reassert itself would likely result in catastrophic losses.

For example, Italian debt is a favorite pick for 2021, and certainly not because anyone is head-over-heels enamored with the fundamentals. Rather, at 1.75%, Italy’s 50-year debt looks enticing relative to alternatives.

Note that we’re back to the “relativity” discussion, which I recently described as having worn out its welcome. While asset allocators are compelled to allocate, there comes a point when speaking in terms of “relative value” is meaningless — no matter how much emphasis you put on the word “relative.”

If stocks are trading at dot-com multiples and yields on, say, Spanish and Portuguese debt are sitting at zero, everything is expensive. Talking about “relative” value in such a scenario reminds me of teenagers in the 80s asking each other which slasher flick villain they’d “rather” be chased by: Freddy Krueger, Jason Voorhees, or Michael Myers. The answer is: None of them.

In any event, Bloomberg’s Brian Chappatta (who, in May, inadvertently hit a nerve with me by alluding to a purported silver lining in the worst monthly jobs report in the nation’s history) had a good piece out this week called “Bond Traders’ Hot Tip for Next Year? Buy Stocks.”

There’s nothing particularly profound about it, but it does a nice job of capturing the zeitgeist. And, with nearly everyone at Bloomberg having inadvertently hit a nerve with me at some point over the past seven months, I suppose it’s only fair that I lift my moratorium on recommending his opinion pieces.

At one point, he cites Nick Maroutsos, head of global bonds at Janus Henderson. “Let’s be honest,” Maroutsos told Chappatta. “We try to generate cash plus 2% to 3% in our fixed-income portfolios. You can get that in equities in two to three days.”

Right. And you can get it in two to three seconds in Tesla, now a proud member of the S&P which could experience “a small mechanical” change in index volatility as a result of the company’s inclusion, according to Goldman.

And that’s really your only argument (or one of your only arguments) if you want to explain why anyone would be interested in allocating aggressively to fixed income right now. Maroutsos went on to tell Chappatta that thanks to central banks anchoring the front-end, short duration volatility should be low.

“The second COVID wave has further strengthened a high rate of savings accumulation and high portfolio cash levels now ready to be invested in the economic recovery at a time of negative real yields in the developed world,” SocGen’s multi-asset strategy team wrote, in a December outlook piece.

“Currently, equity risk premia against sovereign bonds, but also against corporate credit, are very high,” the bank added, before noting that although they raised their credit exposure in April “based on state interventionism, policy reflation and high credit spreads,” the outlook for next year is more challenging.

“For 2021, we see less expected return but increasing risks, with rising defaults and a new M&A cycle based on a combination of low yields and cheap equities,” SocGen said, reducing exposure on high yield to zero and investment grade to 10% from 17%.

“We stay zero weighted on US Treasurys and core [euro-area] bonds but keep exposure to [the] periphery,” they added.

For what it’s worth, the latest Lipper data showed IG funds took in another $2.53 billion in the week to December 23. Junk funds saw a near $900 million outflow. As a reminder, there’s still been just one week of IG outflows since the Fed stepped in with a backstop for corporate credit.

In the latest edition of BofA’s European credit investor survey, the biggest fear for market participants was a bubble. Nearly half of high-grade investors identified the massive stock of negative-yielding debt as “the most concerning market pricing.” Still, investors suggested IG spreads could tighten further.

Bloomberg’s Chappatta cited BlackRock’s Rick Rieder, who said that when it comes to the “40” part of a 60/40 portfolio, the paucity of yield will likely prompt investors to “hold more cash and mov[e] more to equities.”

The cash bit is something I’ve pondered (and acted on) every month since July. If you can find a cash proxy that yields anything (anything at all), why would you not allocate some of what used to be parked in risk-free government bonds to that vehicle?