{"id":25691,"date":"2011-12-01T06:00:33","date_gmt":"2011-12-01T11:00:33","guid":{"rendered":"http:\/\/countingpips.com\/fx\/2011\/12\/01\/schizophrenic-bond-vigilantes-and-other-market-tales\/"},"modified":"2011-12-01T06:00:33","modified_gmt":"2011-12-01T11:00:33","slug":"schizophrenic-bond-vigilantes-and-other-market-tales","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2011\/12\/01\/schizophrenic-bond-vigilantes-and-other-market-tales\/","title":{"rendered":"Schizophrenic Bond Vigilantes and Other Market Tales"},"content":{"rendered":"

By The Sizemore Letter<\/a><\/p>\n

\"\"<\/a><\/p>\n

Not the Bond vigilante you had in mind?<\/p>\n<\/div>\n

Sometimes it is really hard to believe that Wall Street is run by serious, highly-educated professionals.\u00a0 You wouldn\u2019t hear a doctor use a ludicrous expression like \u201cSanta Claus Rally.\u201d\u00a0<\/strong> You wouldn\u2019t take an accountant seriously if you heard them utter pithy nonsense like \u201cDon\u2019t frown, average down\u201d<\/strong> or \u201cBuy on the rumor, sell on the news.\u201d<\/strong>\u00a0 And you might assume your lawyer was a closet pervert if you heard him speak of \u201cdouble bottoms,\u201d \u201chigher highs\u201d<\/strong> or \u201cviolating the lows.\u201d\u00a0<\/strong> Yet such is the vocabulary of the men and women of the investment profession.<\/p>\n

And if the practitioners seem to make little sense, it is because the markets that they follow make little sense.\u00a0 Stocks soared on Monday, breaking one of the worst seven-day stretches in recent memory.\u00a0 The catalyst?\u00a0 An unsubstantiated rumor that the IMF would be giving Italy an emergency loan.\u00a0 (The IMF denied the rumor, by the way.)<\/p>\n

Don\u2019t waste your time trying to make sense of this or trying to establish cause and effect.\u00a0 It will never make sense because traders don\u2019t really react to information<\/em>.\u00a0 They react to each other.<\/p>\n

\"\"<\/a><\/p>\n

The debt is just this big, yes?<\/p>\n<\/div>\n

The European crisis is a case in point.\u00a0 Italy is sliding towards default because its demise has become a self-fulfilling prophecy.\u00a0 Yes, Italy has shamefully high levels of debt due to years of irresponsible governance (thank you, Mr. Berlusconi<\/a>).\u00a0 But then, so does Japan.\u00a0 Japan\u2019s public debt is 220 percent of GDP compared to Italy\u2019s 120 percent of GDP. Italy, unlike Japan, is also running a primary budget surplus.\u00a0 Before interest costs, Italy\u2019s books are in the black.\u00a0 Japan certainly cannot boast this. Yet Japan remains a \u201csafe haven\u201d while Italy is on the verge of meltdown.<\/p>\n

Why?\u00a0 In the circular logic of markets, Japan is safe and can continue to service its gargantuan debts indefinitely because<\/em> the interest rate it pays is low.\u00a0 Rather than rates adjusting to the perception of risk, the perception of risk has adjusted to an environment of low rates.\u00a0 Yet this circular reasoning flows the other way in Europe. Italian yields are not rising because Italy has suddenly become riskier.\u00a0 Italy has become riskier because rising rates make it harder for the country to service its debts.<\/p>\n

One might conclude that the so-called \u201cbond vigilantes\u201d suffer from severe schizophrenia.<\/p>\n

As investors, we can learn a few important lessons from this.<\/p>\n

    \n
  1. When you borrow money you subject yourself to the often cruel whims of the capital markets.\u00a0 This is as true for countries as it is for companies and individuals.<\/li>\n
  2. Risk has a price, and you should never pay too much for it.\u00a0 Neither party is likely to come out well in the end.<\/li>\n<\/ol>\n

    If bond investors had demanded higher borrowing rates from Italy years ago, we wouldn\u2019t be in this mess today.\u00a0 Italy would have been forced to borrow less money and live within her means.\u00a0 Likewise, when investors shower companies with capital and bid their stock prices to ridiculous levels, both the investors and the company suffers.\u00a0 Management makes suboptimal decisions and the investors generally see poor returns going forward.<\/p>\n

    Government debt has, in the words of newsletter writer James Grant, moved from offering a \u201crisk free return\u201d<\/strong> to a \u201creturn free risk.\u201d\u00a0<\/strong><\/p>\n

    With all of this said, where should investors put their money?\u00a0 Staying in cash is not a viable long-term option, and investors would be out of their mind to put money in most bonds at current prices.<\/p>\n

    Given that this article has focused on the irrationality of markets, my answer might surprise you.\u00a0 I recommend that investors turn to equities.<\/em><\/p>\n

    This is not a call to simply buy an S&P 500 index fund and “buy, hold and pray.”\u00a0 Instead, I recommend that investors specifically pick and choose low-debt companies that were able to raise their dividends in the crisis years of 2008 and 2009.<\/strong><\/p>\n

    Any company able to raise<\/em> its dividend during the worst financial crisis in 100 years is a company that can survive anything.\u00a0 Even the destruction of the euro.\u00a0 And given that many stocks trade near valuation lows last seen three decades ago, your chance of permanent or long-term loss would seem to be small.<\/p>\n

    Some candidates to consider: McDonalds (NYSE: $<\/span>MCD<\/a>), Wal-Mart (NYSE: $<\/span>WMT<\/a>), and Walgreen Co. (NYSE: $<\/span>WAG<\/a>).\u00a0<\/strong> All three have raised their dividends every year for the past decade, and all three currently yield more than the 10-year bonds of the United States, Germany, or Japan.<\/p>\n

    If you liked this article by Sizemore Insights<\/em>, you\u2019d probably enjoy The Sizemore Investment Letter<\/em>, our premium members-only newsletter. Click here<\/a><\/strong> for more information.<\/p>\n","protected":false},"excerpt":{"rendered":"

    By The Sizemore Letter Not the Bond vigilante you had in mind? Sometimes it is really hard to believe that Wall Street is run by serious, highly-educated professionals.\u00a0 You wouldn\u2019t hear a doctor use a ludicrous expression like \u201cSanta Claus Rally.\u201d\u00a0 You wouldn\u2019t take an accountant seriously if you heard them utter pithy nonsense like … <\/p>\n

    Continue reading “Schizophrenic Bond Vigilantes and Other Market Tales”<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-25691","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/25691","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/comments?post=25691"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/25691\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/media?parent=25691"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/categories?post=25691"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/tags?post=25691"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}