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Bizarro World – When Did It Start?

Negative DebtDouble Click on Image for a Full Size View

In my opinion, we have officially moved into Bizarro World.  What is that?  If you are a fan of Seinfeld, you will recall that Elaine breaks up with her boyfriend Kevin but they decide to “just be friends.” Much to Elaine’s surprise, Kevin is thrilled at the idea, and starts becoming a much more reliable friend than Jerry. Jerry suggests to Elaine that Kevin is “Bizarro Jerry”, and explains the comic book concept of Bizarro World.  In popular culture, “Bizarro World” has come to mean a situation or setting which is weirdly inverted or opposite to expectations.

This week, we entered Bizzaro World when Greece, the least credit worthy country in Europe and one that continually teeters on the edge of bankruptcy, started issuing negative yielding bonds.

What does that mean?  Someone (in this case most likely the European Central Bank, the “ECB”) loans Greece money when they buy their bonds – but instead of earning interest on the loan, they agree to negative interest which means that instead of getting all of their money back at the end of the loan term, the get back less than they invested.

For a number of years, various European countries and corporations have been issuing negative yielding bonds.  It is definitely a concept foreign to us here in the states, but the European Central Bank came up with this scheme as a way to stimulate the economy in Europe.  Over time, the negative interest rates have worked their way into the banking system, with European banks issuing loans with negative rates and charging people interest to deposit money with them.

The banks in Europe are by and large in terrible shape, not able to make enough money to maintain or grow their capital base.  Yet, the ECB continues to double down on their negative interest rate policy in spite of its failure to stimulate the economy.  In the chart above, you can see that Switzerland has negative yielding debt that they are issuing for 30 years.  Would any sensible investor lock up their money for 30 years knowing that in 30 years they will receive back less than they invested and they will have not received any cash flow from it during all those years.

In calculating what a $1,000 30-year Swiss Bond with a negative yield of -0.058% would give you in 30 years, the formula is:  $1,000*(1-0.058)^30 = -$166.54.  Now, I may just be a poor country banker, but even I can see that receiving a -$164.54 reduction to my original capital in 30 years in return for my $1,000 loan to them today is a bad deal for whomever buys this bond.  So why are people buying them, let alone the less credit worthy European countries like Greece?

The ECB is buying the bonds to inject liquidity into its constituent countries to try to stimulate growth.  This policy has failed since they started it a decade ago, but they are now trapped and cannot resume a normalized rate policy for fear of causing a world-wide economic depression.  Oh, and in case that news is not bad enough, in June our own Federal Reserve announced through much government double-talk that they had adopted new rules for the “lower band” of interest rates – which means they are now prepared to take rates negative here in the states if they deem it to be advisable.  God forbid they close their failed Keynesian Economics textbooks and actually look at the damage that policy has done to Europe.

From the bond traders I’ve talked to, they tell me that the investment houses and mutual funds focused on European fixed income investments buy these to trade them, hoping that yields will get more negative which will drive the price higher.  Over the 35+ years that I’ve managed money for clients, I’ve always called this the “greater fool” theory of investing:  buying an investment that has no fundamental way to make you money just because you believe you can sell it to some sucker for more than you paid.

It is very similar to how the big investment houses operate when they manage your money.  In June they were planning to sell to their clients an IPO of a company named We Work which they had valued at $50 billion.  Since then, and credit to the independent investment analysts out there who exposed the company’s problems – it is not a technology company as the company and the Wall Street banks were marketing it as but rather a real estate company that owns no tangible real estate and has long term leases at top of market pricing across the world.  As of last week, We Work was selling its corporate jet, firing its CEO and founder, and trying to secure lines of credit to avoid bankruptcy.

We are economically in a very difficult position.  Our Fed continues to pump liquidity into the US economy, but we continue to see economic reports of slowing in both the manufacturing and service sectors of the economy.  Third quarter corporate earnings reports start hitting the wire next week, and all forecasts are for continued softness in earnings which are being called by many an earnings recession.  There is a very good chance that the Fed will lower rates once again at its meeting later this month, yet the stock market remains close to its all time high.

Every move to add liquidity to the US economy is cheered by Wall Street yet the market peaked in July prior to the initial rate cut and has not been able to move above that level.  The trade war with China which is definitely having a negative impact on corporate earnings for companies that export a significant portion of their product to China.  However, with every tweet out of the White House announcing an end to the trade war or that a deal is imminent – believable or not – the market seems to rally and keep us near the July high.

In a world that has turned into the opposite of logical, with Bizarro economic policies and Bizarro investment decisions by many institutions, we will continue to play defense with cash equivalents, bonds, and precious metals.  Hard assets and longer dated treasury bonds have consistently over time been the best insurance with the best investment returns as asset classes during times of crisis.  Cash Equivalents have provided outsized returns when viewed as your opportunity to buy undervalued assets when everyone else is forced to sell.

Until we return to a more normalized economic and investment environment, playing defense is the wise move and following the herd by buying stocks at all time highs is being the greater fool.