There is a saying that even a blind squirrel occasionally finds a nut. I am left wondering about this as I note that the former Chair of the US Federal Reserve Alan Greenspan has posted a warning about bond markets. From Bloomberg.
Equity bears hunting for excess in the stock market might be better off worrying about bond prices, Alan Greenspan says. That’s where the actual bubble is, and when it pops, it’ll be bad for everyone.
Actually that is troubling on two counts. The simplest is the existence of extraordinarily high bond prices and low and in some cases negative yields. The next is that fact that his successors in charge of the various central banks may start pumping more monetary easing into this bubble to stop it deflating and it being “bad for everyone”. Indeed maybe this mornings ECB monthly bulletin is already on the case.
Looking ahead, the Governing Council confirmed that a very substantial degree of monetary accommodation is needed for euro area inflation pressures to gradually build up and support headline inflation developments in the medium term.
Let us look at what he actually said.
“By any measure, real long-term interest rates are much too low and therefore unsustainable,” the former Federal Reserve chairman, 91, said in an interview. “When they move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace.”
I find it intriguing that he argues that there is no bubble in stock prices which are far higher than when he thought they were the result of “irrational exuberance” . After all low bond yields must be supporting the share prices of pretty much any stock with a solid dividend in a world where investors are so yield hungry that even index-linked Gilts have been used as such.
What is a bubble?
This is hard to define but involves extreme price rises which are then hard to justify with past metrics or measurement techniques. With convenient timing we have seen a clear demonstration of one only this week as something extraordinary develops. From Sky Sports News.
Sky sources: Neymar agrees 5-year-deal at PSG worth £450m, earning £515,000-a-week after tax. More on SSN.
One sign that we are in the “bubbilicious” zone is that no-one is sure of the exact price as I note others suggesting the deal is £576 million. You could drive the whole London bus fleet through the difference. The next sign is that people immediately assure you that everything is just fine as it is normal. From the BBC.
Mourinho said: “Expensive are the ones who get into a certain level without a certain quality. For £200m, I don’t think [Neymar] is expensive.
To be fair he pointed out that there would however be consequences.
“I think he’s expensive in the fact that now you are going to have more players at £100m, you are going have more players at £80m and more players at £60m. And I think that’s the problem.”
Of course Jose will be relieved that what was previously perceived as a large sum spent on Paul Pogba now looks relatively cheap. Oh and did I say that the numbers get confused?
PSG’s total outlay across the initial five-year deal will come to £400m.
If Sky are correct the high property prices we look at will be no problem as he will earn in a mere 8 months enough to buy the highest price flat they could find in Paris ( £18 million). The rub if there is one is that the price could easily rise if they know he is the buyer!
The comparison with the previous record does give us another clue because if we look at the Paul Pogba transfer it has taken only one year for the previous record to be doubled. That speed and indeed acceleration was seen in both the South Sea Bubble and the Tulip Mania.
Perhaps there was a prescient sign some years ago when the team who has fans who are especially keen on blowing bubbles was on the case. From SkyKaveh.
West Ham were close to signing Neymar from Santos in 2010. Offered £25m but move collapsed when Santos asked for more money
Back to bonds
If we look at market levels then the warning lights flash especially in places where investors are paying to get bonds. If we look at the Euro area then a brief check saw me note that for 2 years yields are negative in Germany, France, Belgium, Italy and Spain. For Germany especially investors can go further out in terms of maturity and get a negative yield. Does that define a bubble on its own as they are paying for something which is supposed to pay you?! There are two additional factors to throw in which is that the real yield situation is even worse as over the next two years inflation looks set to be positive at somewhere between 1% and 2%. Also if we look at Spain with economic growth having been ~3% or so a year for a bit why would you buy a bond at anything like these levels?
Another sign of a bubble that has worked pretty well over time is that you find the Japanese buying it. So I noted this earlier from @liukzilla.
Here we do get something of a catch as the issue of foreign investors buying involves the currency as well. Whether that is a sign of the Euro peaking I do not know but in a way it shows another form of looking for yield if you can call a profit a yield. Also there is an issue here of Japanese investors buying foreign bonds not only because there is little or no yield to be found at home but also because the Bank of Japan is soaking up the supply of what there is.
If we survey the situation we see that prices and yields especially in what we consider to be the first world do show “bubbilicious” signs. If we look at my home country of the UK it seemed extraordinary when the ten-year Gilt yield went below 2% and yet it is now around 1.2%. Of course the Bank of England with its “Sledgehammer” QE a year ago blew so much that it fell briefly to 0.5% in an effort which was a type of financial vandalism as we set yet again assets prioritised over the real economy. What we are not seeing is an acceleration unless perhaps we move to real yields which have dropped as inflation has picked up.
So far I have looked at sovereign bonds but this has also spilled over into corporate bonds especially with central banks buying them. We have seen them issued at negative yields as well which makes us wonder how that all works if one of the companies should ever go bust. Yet we also need to remind ourselves that there are geographical issues as we look around as Africa has double-digit yields in many places and according to Bloomberg buying short dated bonds in the Venezuelan state oil company yields 152% although the ride would not be good for your heart rate.