September 7, 2010
If an investor is willing to hold those bonds to maturity, then there is a very high likelihood that they'll get all their interest and their principal back, right?
That's true. It is possible that the unthinkable could happen somewhere down the line, because we are in an environment where the unthinkable has happened so many times in the past three years. It has become commonplace, with bailouts of car companies and of major banks.
Let’s say you could read any day’s New York Times and had the advantage of being able to see into the future. If in 2005 you received a copy of the 2010 New York Times, you probably wouldn't believe what you were reading. But since the unthinkable is now the norm, at some point the municipal bond market may become subject to taxation. That is a bigger concern than a default concern.
Does it worry you at all that so much money has flowed into bond market funds, particularly from individual investors, and that money might flow out just as quickly as it flowed in?
I'm concerned up to a point, but I'm not concerned to the point that you've outlined. It isn’t going to flow out as quickly as it flowed in. More likely it will be like the way China is viewing the Treasury market. They are not buying anymore. They are selling a little, but they are not bailing out. That will be likely the way bond flows will level off thanks to the very low interest rates.
I wonder if equity flows won't increase in the relatively near term. As we talked about earlier, with the low yields on a two-year Treasury, some opportunistic stock investing starts to become a reasonable alternative even if there will be volatility and you don't want to go in on a buy-and-hold basis. It just seems like investors have been pushed out the risk spectrum in the bond market, out the yield curve, out into risk sectors thanks to zero interest rates.
Once you get the 10-year Treasury down to 250 basis points, you start to wonder why – I know this is becoming a popular theme – a portfolio of good-quality, low-debt, dividend-paying stocks isn’t a reasonable alternative. The dividend is moderately higher than the yields on the ten-year Treasury. That relative value judgment seems sensible to make even though you're talking about substantially higher volatility in the stock market. You don't have an earnings penalty from moving from the ten-year Treasury in to stocks.
I could easily see investors at the margin and on a trend basis curtailing their bond flows and moving instead into the equity market. That's strange for a bond guy to say. Bond guys are always supposed to say “stocks or death,” but on a relative-value basis the stock market is starting to offer competition, based on the dividend yield relative to the Treasury market. There is no denying that fact.
You touched briefly on gold before. Do you have any particular views on gold, or commodities in general at this point?
I'm agnostic on the gold market. It is awfully faddish. Gold flows have been up something like nine years in a row. If you said seven years ago that you were interested in buying gold, people would want to get away from you at a cocktail party, because you were some kind of a freak. Now, you turn on the radio and you've got these talk show hosts all touting gold vendors. They say, “I buy my gold from XYZ gold group,” as if the next questions should be, “who do you by your gold from? You are buying gold, right?” It is awfully faddish.
At the same time, the undeniable case for gold is that if it becomes even more faddish, there really isn't that much of it. It is scarce. If everybody decides they want a 2% or 5% allocation – it doesn't have to be very big on average – it is certainly supportive of the price. Undeniably, the situation in Europe with Greece that's all gotten all the headlines has not been resolved. When you have that type of problem with certain pockets of government debt, it is not surprising that investors diversified.
One of my phrases that I cooked up about three years ago was investors need to “diversify their diversification,” which means we’ve got to get away from the idea of a diversified portfolio of 60% equities and 40% bonds. There are other asset classes that you need to think about, because we are not going to be in the same paradigm going forward that we have been in for the last 30 years. We had a debt-driven, unnaturally stable economy, thanks to debt coming to the rescue every time the economy, left to its own devices, looked weak.
Gold and other real assets like land, non-US investments, and developing countries with a standard of living going up thanks to globalization, are things that investors should have started diversifying into – including gold if you are so inclined. I'm not a big gold guy, but anything that's sort of a currency unto itself could fill that role. It could be gemstones. It could be land.
Could it be oil?
Sure. It could be copper mines. I was talking to the guy who founded Qualcomm, and he said “no copper. The world is wireless.” But you still need copper for electricity, if nothing else.
All of these things are sensible alternatives. At the end of last year the Greek bond yield, which no one talks about anymore, was at 5%. When people woke up to the problems with their fiscal situation, it pushed through 6% and exploded up briefly on an intra-day basis to 20%. Do you know what it is today? It's at 12%, not exactly low.
In spite of the bailout from the northern European countries, the situation in southern Europe is probably moving on to its second chapter. Now that the summer is over, people are going to start coming back and looking at things.
Gold could benefit in the short term from some of that. Gold has gone up a lot. It's getting very trendy. To the extent that one worries about bonds for being trendy, you should equally worry about gold as being trendy.
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