The Future Is Administered

You know, there’s still nearly $15 trillion in negative-yielding debt out there.

That’s just a friendly reminder at the end of a week that found bond yields tumbling as a positioning shakeout conspired with an endless deluge of “Delta” variant headlines to create what I’ve characterized as a “false optic” growth scare.

While hardly an earth-shattering observation, a world awash in negative-yielding debt is conducive to risk-taking, which helps explain the persistent bid for risky assets. This is how QE was supposed to “work.” Ben Bernanke told the public as much in a 2010 Op-Ed for The Washington Post:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate this additional action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

A dozen years on, Bernanke’s assessment (above) comes across as hopelessly naive on multiple fronts, but for the purposes of this brief Friday missive, just note that it belies the Frankenstein monster the global fixed income market has become.

I doubt seriously Bernanke imagined that, a decade on, the entire world would be immersed in QE and that price signals would be as distorted as they are across virtually every sovereign and corporate bond market you care to consult.

It’s notable that we’re back to $14.7 trillion in negative-yielding debt. That’s up from $13.4 trillion just a week ago.

As BofA’s Michael Hartnett suggested in the latest edition of the bank’s weekly “Flow Show” series, the persistence of upside down fixed income dynamics is, in some respects, a paradox when juxtaposed with stimulus. “$30 trillion of global monetary and fiscal stimulus announced and still $14 trillion of negatively-yielding global bonds,” he wrote.

“Still” could mean a couple of (related) things in this context.

First, the bond market “vigilantes” of yore are either inept or have simply given up on fighting policymakers armed with printing presses. That, even as the kind of unprecedented policy profligacy on display across the developed world “should” have sparked a powerful revolt. The average yield on 10-year government bonds across the G-10 is just 0.3%.

Second, in a “normal” world, flagging breakevens and deeply depressed real yields would convey something bad about the outlook for the economy. So, when set against the amount of stimulus delivered, a massive pile of negative-yielding debt could be construed as a sign of policy impotence, as least as it relates to the real economy. That wouldn’t be anything new on the monetary side. Central banks have struggled to deliver robust economic outcomes for most of the post-financial crisis era. But considering the extent to which monetary policy is now explicitly enabling fiscal policy, you’d expect more efficiency when it comes to policy transmission. And, indeed, economies have rebounded rapidly. But bond yields don’t reflect it.

Ultimately, this is a circular discussion. There’s nothing “impotent” about easing when it comes to asset prices. The “poor level of yields and a Wall Street-dependent Fed remain key reasons why stock and credit investors still believe in TINA,” Hartnett wrote. Of course, the “poor level of yields” is in no small part attributable to ongoing monthly bond-buying by central banks. And, as I’ve reiterated on too many occasions to count, the fixed income universe is now so far afield — so far from market clearing prices — that the withdrawal of accommodation would invariably trigger a collapse, driving yields sharply higher in an extremely disorderly selloff, tightening financial conditions dramatically in the process. Tighter financial conditions would choke the real economy.

Increasingly, I doubt the capacity of most market participants (analysts included) to understand the ramifications of this. Running down central bank balance sheets is a non-starter. They’ll never (ever) be able to become active sellers in size, of the government bonds they hold. And, by now, the prospect of a passive runoff seems unlikely too. The Fed tried that and it dead-ended in a stock selloff (Q4 2018) and a funding squeeze (September of 2019). There’s no exit ramp.

Eventually, all central banks in developed economies will buy stocks (or equity ETFs) as a matter of course and words like “emergency” and “exigent” will become increasingly antiquated when it comes to describing what, just ten years ago, counted as “extraordinary” measures.

The Fed is in the process of winding down some crisis facilities and selling its corporate bond holdings, but that latter genie will never go back in the bottle. They bought corporate bonds. They’ll do it again at some point. And the conditions under which it’s deemed “necessary” will become less and less exigent until it simply becomes standard operating procedure. Just as the BoJ buys ETFs on days when the Topix falls “too much.”

Late last year, the BOJ became the largest owner of Japanese stocks.

I’m not entirely sure what this means for analysts and fund managers going forward. If prices are administered, there won’t be much to “analyze.”

The concept of “alpha” will still exist, but more as a theoretical possibility. The vast majority of market participants, knowing rising stock prices are seen as a kind of public good underwritten by the currency-issuing sovereign, won’t have much interest in chasing it. That’ll be especially true if the fees associated with active management are exorbitant.

Additionally, it’s now clear that armies of retail investors can simply will a company back to life, Lazarus style, raising a variety of existential questions, not least of which is whether it’s ever safe to short something in size, even when you’re absolutely sure the target is facing economic oblivion. For activist funds, what clout could they possibly wield in a world where the government, through ongoing purchases of equity ETFs (for example), becomes the largest shareholder?

In any case, global equities took in “just” $6.8 billion during the latest weekly reporting period (figure below). The YTD total is now $591 billion.

Investment grade credit, meanwhile, took in $11.2 billion.

The S&P’s trailing multiple is now 30x, twice the 100-year average and the highest in a century (figure on the left, below).

At BofA, private client equity allocations are at a record high near 65%.

Ironically, the best strategy in a world of administered equity prices will just be the same as the best strategy in the era of market-determined prices: Buy an index fund and reinvest the dividends.

As far as the social consequences, one idea might simply be for central banks to buy stocks and then distribute them to the middle-class and the poor — then go buy some more to ensure prices keep rising.

Occasionally, I like to rekindle my playful (if somewhat unnerving) description of the future.

Imagine a dystopian metropolis. There’s a break in the rain. The sidewalks and streets are red-tinged glass as puddles reflect the city lights. You’re looking out from an alley. A girl walks by holding her umbrella. Above, today’s administered prices scroll across a ticker tape.

Videos of the daily price-setting press conferences play in a loop, as they do every night from 8 PM to 9 PM on every electronic billboard from New York to London to Tokyo.

They say it promotes “transparency.” It’s important, they say, for the public to understand “the process.”

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