International Bonds

Bonds are not something I know much about — and they scare me because they appear to have so little upside. But as I’ve looked at them I realize there is a huge amount of diversity there and I need that. Maybe later I’ll look at corporate/junk – but today is international.

I have zero interest in buying individual bonds. So this is one area where it is worth buying some sort of fund and paying the expense fees to have someone else manage them. I also have less than zero interest in buying “developed” country bonds — US Treasuries, UK gilts, Eurozone, Japanese. They are all dreck.

Nor do I have any interest in buying bonds from other countries that are denominated in those above currencies. Those sorts of bonds (eg dollar-denominated Brazil bonds) are THE cause of all the emerging market crises (defaults, hyperinflation, commodity price swings, dependence on commodity exports to get foreign exchange, etc) of the 1970’s-1990’s that have given emerging markets a bad reputation — and the only beneficiary of those bond issuances were/are the big international trade finance banks (and the governments that issue those currencies).

Fortunately, it does appear that emerging markets really did learn lessons. “Foreign-currency” bonds now represent only 1/3 of the outstanding bonds from those countries. They are now funding themselves using local currencies — which also means they are mostly funding themselves via the savings of their own people. That is really a huge stabilizing force since, as Alexander Hamilton observed, that is one of the major actions that ensures that a government is financially responsible to its own people rather than to foreign entities.

Further, some of those countries are now truly fiscally responsible – unlike the US/etc. Many of them run fiscal surpluses over the course of the economic cycle — are spending less as a % of the economy — and have far lower total debt burdens. The list of “most-indebted” governments is now top-heavy with Europe, Japan – with the US advancing quickly into that sewer. While many “risky” countries have public debt levels that we haven’t seen here for decades. Not to say that all is peaches-and-cream. But it does mean that the “safest” government bond yields are in places we might not feel “safe” in — and bonds (esp sovereign-level credit) add major stability/income to a portfolio.

There are two exchange-traded fund options that fit the above criteria — EMLC, ELD — and a few closed-end fund options.

EMLC — Passively follows a “local-currency” index. Forget it. This means that over time, the ETF will end up loading itself down with the most-indebted just as stock indexes load themselves with the big-cap.

ELD — Actively managed. Says its investment policy focuses on issuer responsibility and such. However, still too new for me to say “OK. I trust you”. So far so good though. Currently diversified well but only in emerging markets — and not going out in duration (4.7 years) reaching for extra yield and risking principal. Will probably yield about 5% — but like most ETF’s won’t pay it except at the end of the year. For now — wait and watch. Potentially very good.

GIM — Closed-end fund. I like CEF’s for bonds because they don’t have to sell underlying bonds simply because investors panic and need liquidity for themselves. Rather, sometimes the CEF just sells at a discount. Unfortunately, right now it is at a 6% premium. EXCELLENT portfolio. Diversified across continents, among emerging markets and solid developed markets (Australia, Sweden, etc), and also makes currency bets (eg currently short the euro/yen in order to fund a carry-trade into other Asian/European bonds). Has a long history and monthly distributions. Duration – 5.4 years; Yld – 5.1%. I don’t like it at its current premium — but this is a perfect fund to put in a GTC order at 6-10% below the current price – or a real stink-bid at 12-15% below — and wait/pray for a flash crash/panic. And if it doesn’t fill in the next 60 days, then just renew the GTC order when it expires. For example, on the day of the May 6 flash crash, GIM traded in a range of $9.97 – $5.00 – the following day traded between $9.40-$8.95 – and recovered back to its then NAV ($9.80) within one week. Pretty good for a sovereign bond fund but the only way to do this is via a low GTC bid because the potential window is so narrow/unpredictable.

There are a couple of CEF’s that I would look at if/after a market crash happens because they are leveraged and hence could get into their own internal margin-call problems which take awhile to work out. And ETF’s probably have better upside after a crash simply because they will own bonds at “forced-liquidation” prices then. But for now, I’ll just put that as something to monitor in the event of some serious financial crisis like late 2008.


Frontrunning the Fed

If you don’t believe that the big Wall St dealers own/run the government via their ownership of the FRBNY and their purchase of politicians; then you haven’t been paying attention. Yesterday, the Federal Reserve did as promised a week ago. They used the proceeds of the paid-off portion of mortgages they’ve bought over the last year to monetize a part — a really really tiny part — of Treasury debt. Specifically, they monetized $2.55 billion of Treasury debt. $21 billion of debt was offered to the Fed for monetization. So how did the Fed choose which 12% of that offered debt to actually monetize?

Answer — The Fed monetized the specific CUSIP issues that the big Wall St primary dealers said should be monetized.

This is a really big story with huge implications down the road. First a bit of economics.

When the Fed monetizes long-term debt, it is attempting to both manage the slope of the entire yield curve and create inflation. The beneficiary of that specific inflation is the entity that receives the money first in exchange for the long-term bond because they get to spend that newly-created money before the impact of that additional money is felt in prices. This is not a new concept. It is THE reason that bankers created the Federal Reserve in the first place because it allows them to a)frontrun everyone else in buying stuff that is trending up in price because of capacity constraints and b)become highly liquid and thus become the ONLY buyer around for stuff that is trending down in price because of capacity excess. IOW, banks created the Federal Reserve (and got it enshrined as a legal monopoly by the govt) so they could profit from both sides of the business cycle. And the monopolization of finance is what leads to the cartelization/corporatization of the economy itself (read a bio of JP Morgan).

When the Fed only monetizes a portion of long-term debt; then not all Treasury debt is equal. Those specific issues (CUSIP’s) that are monetized now are worth more than other issues which come due at the same time in the future. Those who know what will be monetized can profit twice by buying the monetized CUSIP and shorting the non-monetized one. The mechanics of this stuff is way above my pay grade but there is something for us minnows to take away from this.

First — it is the minnows demand for “Treasury debt” in general (thus ignoring specific CUSIP’s) that allows this game and ensures that most of the profits go to the sharks. You want to stop this game? Then stop buying Treasuries — and stop funding entities (via your bank account or the stock of corporations that are hoarding Treasuries) that buy Treasuries.

Second, the specific criteria (avoid the cheapest-to-deliver) that the Fed used here is designed specifically to keep the derivatives market going. ie – to keep the big Wall St primary dealers going – even when they are shorting Treasuries. It also has the effect of making the long-term fiscal situation of the US worse — because the debt that is monetized is the lowest interest cost debt rather than the highest interest cost debt. This alone is the sort of kleptocratic insanity that is now leading me to reduce my long-term “normal” US allocation to under 20% (which includes cash). Bluntly, the US is run by a bunch of crooks and there is no reason to invest in the US. The bastards won’t change — and Americans won’t kill/overthrow them — so get out. I now understand why Jim Rogers moved his family to Singapore.

Third, now that the entire Treasury yield curve is being managed/rigged by the Fed, it is no longer an indicator of “risk-free” yield. The big Wall St houses will attempt to keep using this curve as their discount rate for valuing other assets (stocks, housing, etc) – in order to keep those asset markets propped up. And it may well work for awhile – perhaps a long long while. But that is only the source of asset bubbles (ie stock market rampup’s the day of/after every “monetization day” – upcoming days are 8/19, 8/24, 8/26, 9/1) — not of any sustainable growth. And when it reverses, it will reverse hard and fast. So raise your allocation to “real” assets that will preserve their value/utility in the event that the reversal happens. And by “real” assets, I mean REAL assets — not financial assets that are supposedly based on the price of real assets.

Finally, this little circle jerk between the derivatives market and “sovereign” bonds is telling me that upcoming sovereign debt defaults will be magnitudes larger in their effect than they have ever been in the past. Before, sovereign defaults have generally affected mainly taxes and spending by government. Now, they will affect EVERYTHING in the market. All of your assets. All of your dependence on others to provide you with daily needs. The most vulnerable countries are now precisely those where the division of labor has advanced the most and where people have benefited the most from it. Certainly there is nothing imminent to warrant fear. But neither is it going to be reasonable to expect a warning when fear is warranted. Indeed, considering that the sharks own the system; expect deceit/dishonesty from them when things do begin to deteriorate because for them that day will be a golden opportunity. So advice for minnows — get prepared, keep it simple, and don’t believe anyone from/in NYC/DC.

Retail Investors

Retail investors (minnows all) have been pulling money out of stock mutual funds ever since the “flash crash”. For good and obvious reasons – because however much the sharks mock the investment intelligence of minnows; minnows do know when the game is rigged and when they have no chance. Unfortunately, the minnows are jumping into domestic taxable bond funds right now — mainly treasuries issued by an entity (government) that the sharks obviously own — at their bubbliest prices ever — so maybe the sharks are right.

At any rate, I do agree with others who say that this pullout from equities — 28 of the last 43 months have seen equity outflows – may well be the beginnings of a generational disdain for stocks. If so, expect serious PE compression over time and ignore most equity valuation measures from the last 30 years.

And now that portfolios are shifting towards T-bonds, expect violence on the part of the “shareholder class” if government tries to hyperinflate away their bonds. I doubt American minnows will be as vigilant on this as German minnows are now. But this is still a powerful – and growing – force that will favor deflation. Only time will tell whether the forces favoring hyperinflation/default (the young mostly) become influential at all in the debate. Perhaps another stimulus program — free iPads and ecstasy/meth – in combination with horrible education – will numb that demographic into dumb.

Sovereign Debt Risks

CMA has released their Q2 2010 Sovereign Risk Report. Only 8 sovereign issuers (including the US) indicated a lower risk of default in Q2. Average “cost of protection” (ie CDS price — whatever that is actually worth when it comes to sovereign debt) rose by 30% during Q2. Default risks (5 year timeframe) are >50% for the worst offenders (Venezuela, Greece, Argentina) to 11-12% for a standard aa- rated sovereign. The only implied aaa rated sovereigns (3-4% risk of default) are Norway, Finland, US, Denmark, Sweden, Germany.

So much for “safety”. Those who are rushing to sovereign bonds for safety run a real risk of getting slaughtered – for little/no possible upside. It looks more and more like the world is heading into one of its periodic sovereign debt crises. In the past, these cycles have peaked with 30-50% of all sovereigns in default on their debt.

Source: “This Time is Different: A Panoramic View of Eight Centuries of
Financial Crises,” by Reinhart and Rogoff

Interesting consequences of this. (hyper)Inflation in a country tends to lag its sovereign debt default — as a consequence of it. The US and other aaa countries may lag (despite obscene fiscal policies here in the US) – and indeed perhaps even become “more creditworthy” simply because in a world this irresponsible, any raft looks like a “safe haven”. Hard to know how much money worldwide is gonna slosh around looking for any safety it can find. But this cycle will not end well. Think blood. Lots of blood in a global war of creditors and debtors.

As an aside — I would have loved to link to Amazon so you could buy the excellent book cited (and supported this site in the process). But the sharks in our moronic Colorado legislature decided to try to play their part in destroying online commerce – and so Amazon and other “affiliate” programs have now cancelled all their Colorado affiliates. Thus eliminating a number of revenue streams for Colorado Internet businesses and startups. If you live in Colorado and would like to protest (HB10-1193 is the legislation), please contact whichever clown you elected to power. And please don’t buy this book or anything else from Amazon. And please please please vote against all incumbent jackasses this November.

Expect this same sort of nonsense to occur at the federal level soon. [On edit] haha. It has. A Massachusetts congressional jackass named Delahunt just introduced federal legislation to do the same thing. Get ready for the giant sucking sound of more unemployment.