February 14, 2015

Too Low For Zero

Nothing seems to make much sense,
It’s all just Greek to me
You know I’m too low, too low,
Too low for zero.

E. John/B. Taupin 1983


Elton John’s 1983 hit “Too low for Zero” from the album of the same name describes an exhausted gambler on a losing streak. He employs several methods in order to try and cure his recently developed insomnia but nothing seems to be working. We draw no comfort that the gambler has any solution to his current woes rather than to just “start winning”, but at the moment he is so down he is below, or worse, than zero.

And so we continue down the path of money printing and competitive devaluations in an attempt to pump-prime economies via both cheaper interest and currency. This is a massive experiment undertaken by the academics within the various central banks which has no clear exit strategy. Even the RBA has looked a little panicky by cutting rates in early February rather than waiting another month. Denmark and Canada have cut rates multiple times this year outside of the formal meetings. As illustrated in the pages more than once, these coordinated actions are so massive that they are having massive primary and secondary effects (intended and unintended) on asset prices across all classes. Witness house prices in most markets. bond markets powering higher in another leg of a 30y bull market and equity markets detached from valuation fundamentals.

The trouble is that the cratering oil price has killed any nascent synthetic inflation that the CB’s had been trying to incubate. We now have a virtual “moonscape” of yield (US 10y yields 1.75%, Swiss 10y yields -0.10!) in which a massive wall of “return-seeking” money has chased assets into fundamentally dangerous areas. WIth rates so low, shale-oil wildcatters have been using debt rather than equity to finance their operations, which now accounts for 30% of the “high yield” bond market, or “junk bond market” to use its more accurate name. Guess what though? The high yield isn’t so high, and the average financing rates on these notes and bonds is around 6…for that sort of risk? Remember with a bond you get interest and then your money back at the there is no “blue sky” here. To lend these guys money I would have thought the more appropriate rate would have been in the 12-15% category. This will end in tears, the only thing not clear is the level of contagion. Watch that space.

There are several clouds on the horizon at present which have amped up market volatility. Borrowing from Dan Loeb’s “hanted house” theme, they are as follows:


  • Signs of lower growth across the globe despite falling oil prices
  • Depegging of the Swiss Franc
  • Declining currencies from Japan to Europe putting pressure on the non-US earnings stream of many US multi-nationals
  • Lack of clarity over the proposed fed rate hikes
  • The rise of populism and anti-austerity left in Europe
  • Russian incursions into Ukraine
  • Middle East chaos


So perhaps this might be the year that the local share market beats the US, as despite the banks being on high valuations we have taken huge pain across the mining and energy sectors, and lower energy prices help Asia more than any other continent. As for the US, the struggles of their major trading partners will exert significant gravity, as will the twin headwinds of rising interest rates and a sharply stronger dollar. The US consumer is going to have to some seriously heavy lifting, watch sentiment closely as it ticked down last week for the first time in a year.

The “too low for zero” rate landscape has a habit of forcing investors into investments whereby they are not adequately compensated for the risk. They become “snowblind” whereby the investor makes the mistake of using comparative yield rather than absoluteyield in order to assess the merits of an investment. Unless you are buying one to sell another (taking a view on the spread), the absolute yield is of fundamental importance, the relative is meaningless. For recent blowups, think of the all the mortgage funds that were being used as quasi-CMA’s because they paid a higher yield. Well they paid a higher yield because 95c in the dollar were loaned out as mortgages, and in the panic of 2008 they became frozen, some still are. Not what you wanted from a “cash account”!

Examine your portfolio and make sure any yield makes sense from an absolute standpoint – this storm won’t last forever.

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